South Africa Residence Basis of Taxation

By Profs Kevin and Lindsay Mitchell.

 A Resident

DEFINITION

A ‘resident’ has been defined in section 1 of the Income Tax Act as a

‘(a) natural person who is—

 (i) ordinarily resident in the Republic; or 

(ii) not at any time during the year of assessment ordinarily resident in the Republic, if such person was physically present in the Republic—

(aa) for a period or periods exceeding 91 days in aggregate during the relevant year of  assessment, as well as for a period    or          periods exceeding 91 days in aggregate during each of the three years of assessment preceding such year of assessment; and

(bb) for a period or periods exceeding 549 days in aggregate during such three preceding years of assessment’

‘Provided that—

‘(A) for the purposes of items (aa) and (bb) a day shall include a part of a day; and

‘(B) where a person who is a resident in terms of this subparagraph is physically outside the Republic for a continuous period of at least 330 full days immediately after the day on which such person ceases to be physically present in the Republic, such person shall be deemed not to have been a resident from the day on which such person so ceased to be physically present in the Republic; or

‘(b) person (other than a natural person) which is incorporated, established or formed in the Republic or which has its place of effective management in the Republic (but excluding any international headquarter company).’

NATURAL PERSON – ORDINARILY RESIDENT

The courts have in numerous cases had to interpret the meaning of the words ‘not ordinarily resident’ and ‘not resident’. The factors the court considers when deciding on whether or not a taxpayer is ordinarily resident are the following:

1. The degree of continuity.

2. The mode of life of the taxpayer.

3. The taxpayer’s ‘physical presence’ – although this is not essential.

4. His intention of being in a country. In this regard the courts have held that his ‘domicile’ (in the legal sense) is not relevant, but his intention of being in a country is.

5. The facts surrounding the matter.

Two cases from the Appellate Division of the Supreme Court (now the Supreme Court of Appeal) dealt with the meaning of the term ‘ordinarily resident’. These cases were Cohen v CIR 1946 AD 174, 13 SATC 362 and CIR v Kuttel 1992 (3) SA 242 (A), 54 SATC 298.

Cohen case

Cohen was one of the two directors of OK Bazaars (1929) Ltd. Because it was difficult to obtain merchandise in the Republic, Cohen on behalf of OK Bazaars (1929) Ltd, proceeded abroad to act as its buyer. He was accompanied by his wife, three children and a nurse. Cohen established himself with his wife and family in an apartment in New York from October 1940. Although he had originally planed to be outside South Africa for nine months, this period was extended by a year, and up to 30 June 1942 neither Cohen nor his family had returned to South Africa. In 1939 Cohen had leased a flat in Johannesburg for five years. He furnished it. He sublet this now furnished flat while he was in New York.

While in New York he earned dividends from South African public companies. He claimed that these dividends were exempt from normal tax in South Africa because he was not ‘ordinarily resident’ and not ‘carrying on business’ in South Africa in the years of assessment of dispute. It was unnecessary for the Appellate Division to decide whether in South African law a person could be ordinarily resident in more than one country at the same time.

Schreiner JA, who delivered the judgment of the court, said the following at SATC 371: ‘If, though a man may be “resident” in more than one country at a time, he can only be “ordinarily resident” in one, it would be natural to interpret “ordinarily” by reference to the country of his most fixed or settled residence. But his ordinarily residence would be the country to which he would naturally and as a matter of course return from his wanderings; as contrasted with other lands it might be called his usual or principal residence and would be described more aptly than other countries as his real home. If this suggested meaning were given to “ordinarily” it would not, I think, be logically permissible to hold that a person could be “ordinarily resident” in more than one country at the same time.’

A person can as a matter of law be ordinarily resident in a country from which he was absent throughout the year of assessment, and the question whether a person is ‘ordinarily resident’ in South Africa does not depend solely upon his actions during the particular year. An investigation of his lifestyle before or even after the year of assessment may be necessary to reach a conclusion.

The Appellate Division held that the question whether an individual was resident or ordinarily resident in any particular area for the purposes of the Income Tax Act was one of fact and that there was clearly evidence upon which the Special Court was entitled to find that Cohen had not proved that he was not ordinarily resident in South Africa. It also found that the question whether an individual was in any one year of assessment ordinarily resident in South Africa or elsewhere was not to be determined solely by his actions during that particular year of assessment. His conditions of ordinarily residence during that particular year could be determined by evidence as to his mode of life outside the year of assessment under consideration.

Finally, it found that physical absence during the whole of the year of assessment was not decisive of the question of ‘ordinary residence’.

Kuttel case

Kuttel had emigrated from the Republic to the United States of America in July 1983. Prior to emigrating he had sold some of his assets and invested the proceeds in ESKOM stock. In addition to this investment he held shares in the company that owned the private residence in which he lived while he was resident in the Republic. This residence was not let on his departure but was kept vacant to provide him with accommodation when he returned to the Republic. He did not give up his directorship of a private  company when he left the Republic. Between July 1983 and 28 February 1986 he returned to the Republic on ten occasions, each for a period of less than two months. On two of these occasions he attended directors’ meetings. On all ten occasions he stayed in his former private residence. The main purposes of his visits to the Republic were domestic matters:

6. the schooling of his children,

7. the building of a private yacht,

8. competing in a yacht race in the Republic,

9. attending his late brother’s funeral, and

10. supervising his various investments and business interests in the Republic.

 

The Commissioner, when assessing him for Republic normal taxation, had not granted him the section 10(1)(h) exemption in respect of the interest earned on the ESKOM stock and the section 10(1)(k) exemption in respect of his dividend receipts and accruals. The Commissioner was of the opinion that he was both ‘ordinarily resident’ in the Republic and ‘carrying on business’ in the Republic.

The lower court, at ITC 1501 (1989) 53 SATC 314, found that

11. the taxpayer was ordinarily resident in the United States and not in the Republic; and

12. the mere fact that he was a director of a company did not mean that this directorship

constituted the carrying on of a business; and

13. the taxpayer was neither ordinarily resident nor carrying on business in the Republic, and therefore the exemption provisions of sections 10(1)(h) and 10(1)(k) were available to him.

Accordingly, the interest from ESKOM stock and dividends received by the taxpayer were exempt

from normal tax in the Republic.

The Commissioner appealed against the decision to the Appellate Division on the question of the taxpayer being ‘ordinarily resident’ in the Republic. The Appellate Division (full bench) agreed with the judgment given in ITC 1501 finding that the taxpayer (Mr Kuttel) was not ordinarily resident in the Republic.

The Appellate Division case is reported as CIR v Kuttel 1992 (3) SA 242 (A), 54 SATC 298. In the Appellate Division, Goldstone JA, giving the unanimous judgment, held that ‘a person is “ordinarily resident” where he has his usual or principal residence, that is, what may be described as his real home’.

 

NATURAL PERSON – PHYSICAL PRESENCE

A natural person who is not ordinarily resident in the Republic will also be a resident if he was physically present in the Republic for a period or periods exceeding

14. ninety-one days in aggregate during the current year of assessment, and

15. ninety-one days in aggregate during each of the three years of assessment preceding the

current year of assessment, and

16. 549 days in aggregate during the three preceding years of assessment.

First requirement

The person must be physically present in the Republic for more than ninety-one days in the current year of assessment.

Second requirement

The person must be physically present in the Republic for more than ninety-one days in each of the three previous years of assessment.

Third requirement

The person must be physically present in the Republic for more than 549 days in total during the three previous years of assessment.

Fourth requirement

The person must not be a person who was continuously absent from the Republic for a period of at least 330 days (see below in this regard).

The physical presence test deems a person to be a resident if he was present in the Republic for a total period of more than

17. ninety-one days in the current, and

18. each of the preceding three years of assessment, and

19. a total period of more than 549 days during the preceding three years of assessment.

 

The ninety-one days and the 549 days of physical presence need not be continuous. It is important to note that the 549 days applies to the preceding three years of assessment and not to the current year of assessment. It will, therefore, be necessary to keep detailed records of physical presence in the Republic (see below under ‘Onus’ in this regard).

Part days

A day will include a part of a day for the purposes of the determination of the days of physical presence in the Republic. This means that the days of arrival in and departure from the Republic will count as days of being physically present in the Republic.

Continuous absence

A person who is a resident in terms of the physical presence test will be deemed not to be a resident if he is physically outside the Republic for a continuous period of at least 330 full days immediately after the day on which he ceases to be physically present in the Republic. He will be deemed not to have been a resident from the day on which he ceased to be physically present in the Republic. (This concession does not apply to a person who is ordinarily resident in the Republic, for example, a person who is absent from his home in the Republic for, say, study purposes for a year.)

The period of 330 days must be continuous. Because this concession applies only to a person who has met the physical presence, he must have been physically present in the Republic for more than ninety-one days in the current year of assessment, it means that the period of 330 days will cover two years of assessment, 20. the first, being the year of assessment in which the person was last considered to be a resident in terms of the physical presence test, and 21. the second, being the following year of assessment. The concession applies from the commencement of the 330-day period, so that the qualifying person will be a resident for part of the first year of assessment and a non-resident for the remainder of the first year.

As it is only after the 330-day period has been fulfilled that the person will be deemed not to be a resident. It would seem that prior to this period coming to an end, any employer paying him remuneration would not be aware that he is going to be deemed not to be a resident and therefore it is likely that employees’ tax will be deducted from any remuneration he earns.

Emigration year

The ‘physical presence’ test does not apply to a person who is ordinarily resident in the Republic in the year of assessment. Therefore when a person emigrates from the Republic, because he would have been ordinarily resident in the Republic in the year of assessment prior to his emigration the ‘physical presence’ test cannot be applied in the year of assessment of emigration.

The person will therefore 22. be a resident of the Republic up to the time of his emigration, and 23. not be a resident of the Republic from the day he emigrates.

 

NON-NATURAL PERSONS

A person other than a natural person will be a resident as defined if it is

24. incorporated,

25. established or formed in the Republic, or

26. has its place of effective management in the Republic.

 

Excluded from being a resident is an ‘international headquarter company’ (see below).

 

As far as companies are concerned the wording of the Act was somewhat inconsistent as some provisions required

27. a ‘managed and controlled’ test,

28. whereas others refer to ‘managed or controlled’, and

29. some provisions used the term ‘effectively managed’ in the Republic.

 

The definition of a ‘resident’ is fundamental to the residence basis of taxation and the different provisions and definitions, therefore, have been aligned. The rules introduced for the residence of companies and other entities are similar to those of other countries.

 

To establish whether a person other than a natural person is a resident the following four tests are carried out.

30. The first test is to establish whether the entity is incorporated in the Republic.

31. The second test is to determine whether the entity was either established or formed in the Republic.

32. The third test is to establish whether the entity has its ‘place of effective management’ in the Republic.

33. And the fourth test is to establish whether the entity is an ‘international headquarter company’.

 

If it is an ‘international headquarter company’, then it is not a resident of the Republic.

 

Place of effective management

The Income Tax Act does not define the term ‘place of effective management’. And it would

seem that there is, as yet, no South African case law in this regard.

SARS regards the term ‘place of effective management’ to mean the place where the day-to-day

activities of the business take place. It is where the executive directors and management carry out

the daily activities of the business.

The place where the business is controlled is not the ‘place of effective management’. But if

control is at the same place where the daily activities take place, then the ‘place of effective

management’ is also at the place of control. If these activities do not occur at the same place then

34. the place where the business is managed by its executive directors and management will be the

‘place of effective management’, and

35. the place where the board of directors meet to mange and control its overall business

operations (as opposed to its daily activities) is not the ‘place of effective management’.

If a foreign company which is controlled outside the Republic carries on business in the Republic

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its ‘place of effective management’ is likely to be in the Republic and it will be a resident of the

Republic.

Repealed provisions

The creation of a definition of a ‘resident’ has resulted in the definitions of

36. a ‘domestic company’,

37. an ‘external company’, and

38. a ‘South African company’

being repealed.

INTERNATIONAL HEADQUARTER COMPANY

An ‘international headquarter company’ is defined as a company

39. where its entire equity share capital (100%) is held by persons who are not residents or trusts;

40. where any indirect interest of residents and of any trust (resident or foreign) in its equity share

capital does not exceed 5% in aggregate; and

41. where 90% of the value of its assets represents interests in the equity share capital and loan

capital of its subsidiaries (that are not residents) in which it holds a beneficial interest of at

least 50%.

The above three requirements must all be met.

42. First, none of the equity share capital of the company may be held directly by residents or

trusts.

43. Secondly, if residents or trusts hold an indirect interest in the company, for example, through

their interests in non-resident companies that hold equity shares in the company, that indirect

interest may not exceed 5% in aggregate of the total equity share capital of the company.

44. Thirdly, at least 90% of the value of the company’s assets must represent interests in the

equity share capital and loan capital of non-resident subsidiaries in which it holds a beneficial

interest of at least 50%. It is the ‘value’ of its assets that is relevant and not the cost of the

assets.

 

An international headquarter company is excluded from the definition of a ‘resident’.

The effect of this exclusion is that the provisions of section 9D and section 9E will not apply to it

and the income of its subsidiaries will not form part of the gross income of the international

headquarter company. It will also not be taxed on the dividends received from its foreign

subsidiaries or foreign-sourced income.

As secondary tax on companies (STC) is now imposed only on companies that are residents, the

international headquarter company will also not be subject to STC on its dividends declared.

 

Equity share capital

The term ‘equity share capital’ is defined in section 1 of the Income Tax Act.

It means

‘in relation to any company, its issued share capital excluding any part thereof which, neither as

respects dividends nor as respects capital, carries any right to participate beyond a specified

amount in a distribution, and the expression “equity shares” shall be construed accordingly’.

ONUS

Section 82 of the Act provides that

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‘[t]he burden of proof that any amount is exempt from or not liable to any tax chargeable under

this Act or is subject to any deduction, abatement or set-off in terms of this Act, shall be upon

the person claiming such exemption, non-liability, deduction, abatement or set-off, and upon

the hearing of any appeal from any decision of the Commissioner, the decision shall not be

reversed or altered unless it is shown by the appellant that the decision is wrong’.

A person claiming not to be a resident would be claiming that an amount he has earned or is

entitled to is ‘not liable to any tax chargeable under this Act’.

It would therefore seem that in terms of the provisions of section 82, that the burden of proof on a

person claiming not to be a resident would be upon him (the person) and not on the

Commissioner. As pointed out above it would be upon the person (the resident or non resident) to

keep detailed records of his physical presence (or absence) in (or from) the Republic.

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Taxable Income of a Resident

GROSS INCOME

The definition of ‘gross income’ reads as follows:

‘“gross income”, in relation to any year or period of assessment, means—

‘(i) in the case of any resident, the total amount, in cash or otherwise, received by or accrued to

or in favour of such resident; or

‘(ii) in the case of any person other than a resident, the total amount, in cash or otherwise,

received by or accrued to or in favour of such person from a source within or deemed to be

within the Republic,

during such year or period of assessment, excluding receipts or accruals of a capital nature, but

including, without in any way limiting the scope of this definition, such amounts (whether of a

capital nature or not) so received or accrued as are described hereunder, namely–’.

For a resident gross income is

45. the total amount,

46. in cash or otherwise,

47. received by or accrued to,

48. during the year or period of assessment,

49. excluding receipts or accruals of a capital nature (unless one of the so-called special inclusions

applies).

Source

It must be stressed that as far as residents are concerned the source or deemed source of a receipt

or accrual is of no concern. There is no geographic limitation on the receipts and accruals of

residents.

REPEALED PROVISIONS

Because the source of income is not relevant to residents, certain provisions which applied to

persons ordinarily resident in the Republic and which deemed the following amounts to be

derived from a source within the Republic have been deleted:

50. Section 9(1)(c) – amounts derived from a business carried on by a person ordinarily resident

in the Republic or a domestic company as owner or charterer of a ship or aircraft or from the

disposal of commodities connected with the operation of the ship or aircraft.

51. Section 9(1)(cB) – amounts derived from a business carried on by a person ordinarily resident

in the Republic or a domestic company as the lessor of certain containers.

52. Section 9(1)(d) – amounts derived from services rendered or work or labour done by a person

ordinarily resident in the Republic in the carrying on in the Republic of a trade.

53. Section 9(1)(d)bis – amounts derived by a person ordinarily resident in the Republic from

services rendered or work or labour done outside the Republic during a temporary absence

from the Republic for or on behalf of an employer by whom he is employed in the Republic.

54. Section 9(1)(f) – amounts derived by a person ordinarily resident in the Republic from

services rendered or work or labour done as an officer or crew member of a ship or aircraft

owned or chartered by a person ordinarily resident in the Republic or a domestic company.

Also deleted are the following three provisions:

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55. Section 9(5) – gain made by a person other than a company ordinarily resident in the Republic

or a domestic company on the maturity or disposal of a banker’s acceptance or similar

instrument issued in the Republic or a ‘neighbouring country’.

56. Section 9A – investment income of certain ‘foreign investment companies’ (which are

controlled by persons ordinarily resident in the Republic) in ‘neighbouring countries’ which is

deemed to be derived from a source within the Republic.

57. Section 9C – the taxation of investment income accruing to persons ordinarily resident in the

Republic from foreign sources.

‘LOCAL’ PENSIONS

The deemed source provisions relating to ‘local’ pensions have not been amended and apply to

both residents and non-residents. But then because residents are not taxed on a source basis these

deemed source provisions do not ‘directly’ apply to residents (but see further under the heading

‘Exemptions – “Foreign” Pensions’).

Government

Section 9(1)(g)(i) deems a ‘government’ pension or annuity to be derived by a person from a

source in the Republic if it has been received by or has accrued to him or in his favour by virtue

of any pension or annuity granted to him by

58. the Government,

59. a provincial administration, or

60. a local authority

in the Republic, no matter where payment is made or the funds from which payment is made are

situated or his services have been rendered. But as a resident is already taxed on his world-wide

receipts and accruals this provision is superfluous as far as it relates to a resident.

Non-Government

Section 9(1)(g)(ii) deems a pension or annuity granted by any person, whether residing or

carrying on business in the Republic or not, if the services in respect of which the pension or

annuity was granted were performed within the Republic for at least two years during the ten

years immediately preceding the date from which the pension or annuity first became due to be

from a Republic source.

It then provides for an apportionment if the pension or annuity was granted in respect of services

that were rendered partly within and partly outside the Republic. The portion of the pension or

annuity which bears to the amount of the pension or annuity the same ratio as the period during

which the services were rendered in the Republic bears to the total period during which the

services were rendered is deemed to be from a source within the Republic.

As far as the portion of the pension or annuity is not deemed to be from a Republic source it is

regarded as a ‘foreign’ pension and will qualify for the exemption provided for in

section 10(1)(gC) (see below).

As far as the ‘overall’ position of a resident is concerned, the full pension or annuity will be gross

income (because a resident is taxed on his world-wide receipts and accruals) but then the portion

of the pension or annuity that is not deemed to be from a Republic source will then be exempt

from normal tax in terms of section 10(1)(gC) (see below). The net effect is that the resident is

only taxed in the Republic on the portion that is deemed to be from a Republic source.

EXEMPTIONS

The introduction of the world-wide basis of taxation has resulted in three new exemptions being

legislated, an existing exemption being modified, and a ‘temporary’ exemption becoming

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available.

Foreign services

Crew of ships

Section 10(1)(o)(i) provides an exemption for remuneration derived by a person as an officer or

crew member of a ship that is engaged in the

61. international transportation for reward of passengers or goods; or

62. prospecting for, or the mining of, any minerals from the seabed outside the continental shelf of

the Republic, where the officer or crew member is employed on board the ship solely for the

purposes of the ‘passage’ of the ship.

To qualify for the exemption, the person concerned must have been outside the Republic for a

period or periods exceeding 183 ‘full’ days in aggregate during the year of assessment. This

means that days of departure from or arrival in the Republic, which will not be full days of

absence from the Republic, will not count. The period of absence need not be continuous, because

the provision refers to a ‘period or periods’ exceeding 183 days in aggregate.

Employment abroad

Section 10(1)(o)(ii) provides a new exemption in respect of remuneration for foreign services. It

exempts remuneration derived by a person in respect of services rendered outside the Republic

for or on behalf of an employer if the person concerned was outside the Republic

63. for a period or periods exceeding 183 full days in aggregate during any twelve-month period

commencing or ending during the year of assessment; and

64. for a continuous period exceeding sixty full days during the relevant period of twelve months

and the services were rendered during the period or periods of absence from the Republic.

The period of 183 days need not be continuous. The period exceeding sixty days must, however,

be continuous. And the days must fall within the same period of twelve months. This can be any

period of twelve months, not, for example, a year of assessment, or a calendar year.

This exemption does not apply to remuneration derived in respect of the holding of an office or

from services rendered for or on behalf of an employer referred to in section 9(1)(e), namely, the

Government or semi-government bodies.

The Explanatory Memorandum points out that the effect of this exemption will be monitored to

determine whether certain categories of employees abuse it by earning foreign-employment

income without paying foreign taxation.

‘Foreign’ pensions

Section 10(1)(gC) introduces a new exemption from normal tax in respect of any

65. amount received by or accrued to a resident under the social security system of any other

country; or

66. pension received by or accrued to a resident from a source outside the Republic, which is not

deemed to be from a source in the Republic, in consideration of past employment outside the

Republic.

It is international practice for the country of residence to tax foreign pensions. And from a

practical point of view, at this stage, it is convenient that foreign pensions are not taxed in the

Republic. This is, however, merely an interim measure and the issue of the taxation of foreign

pensions will be revisited over the next three years.

The reason why social security payments by foreign governments are not taxed is because they

are exempt in comparable jurisdictions.

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It should be noted that, at this stage, contributions to foreign pensions and retirement annuity

funds will not be tax deductible.

Designated countries

Section 10(1)(kA) exempts from normal tax so much of any amount received by or accrued to a

company that is a resident from a source outside the Republic as determined in accordance with

section 9F(2).

Section 9F(2) gives the amount of income that will be exempt from tax. It is any amount received

by or accrued during the year of assessment to a company that is a resident from a source outside

the Republic and that is also not deemed to be from a source within the Republic. It must have

been subject to tax in a designated country at a rate of tax of at least 27%.

A ‘designated country’ means a designated country as defined in section 9E, that is, a country

designated by the Minister of Finance under section 9E(8). A list of the countries designated by

the Minister is set out in Lecture 5. It would seem from the Explanatory Memorandum that the

current list of designated countries will soon be extended so as to reduce the current

administrative workload.

The amounts must be subjected to tax in a designated country at a statutory rate of at least 27%

after taking any double taxation agreement into account. The rights of recovery of tax by any

person is ignored. (But a right of recovery in terms of an entitlement to carry back losses arising

during a year of assessment to a prior year of assessment is taken into account.)

If a designated country imposes tax on a company on a progressive basis, the highest rate is

deemed to be the statutory rate.

Blocked funds

Section 9F(3) provides a temporary exemption when there are foreign currency or other

restrictions or limitations (referred to in the Explanatory Memorandum as ‘statutory clogs’) on the

remission of amounts to the Republic. It applies when an amount

67. received by or accrued to a person is required to be included in his gross income, or

68. is required to be included in the income of a resident in terms of section 9D (a controlled

foreign entity),

during the current year of assessment, may not be remitted to the Republic during the current year

of assessment. The cause of the amount not being remitted to the Republic during the current year

of assessment must be as a result of currency or other restrictions or limitations imposed in terms

of the laws of the country where the amount was received or accrued. The amount is deemed not

to have been received or accrued to the person or resident during the current year of assessment.

It will be included in his gross income in the year during which it may be remitted to the

Republic.

ALLOWANCES AND DEDUCTIONS

General deduction formula

With the introduction of the world-wide basis of taxation the positive test aspect of the general

deduction formula previously contained in section 11(a) and (b) has been ‘consolidated’ into a

single provision.

Section 11(a) in its amended form reads as follows:

‘For the purpose of determining the taxable income derived by any person from carrying on

any trade, there shall be allowed as deductions from the income of such person so derived–

(a) expenditure and losses actually incurred in the production of the income, provided such

expenditure and losses are not of a capital nature.’

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Capital allowances

An asset qualifying for a capital allowance may be used for the purposes of a trade carried on

outside the Republic. Under the source basis of taxation it would not have produced income

taxable under the Act. Amendments have been made to most capital allowances to ensure that the

now ‘qualifying’ allowances on these assets under the residence basis of taxation are based not on

their original cost but on a deemed ‘tax value’. This deemed tax value is the tax value that would

have applied had the asset always qualified for its appropriate capital allowances in the past.

Section 11(e)

The provisions of section 11(e) which provide the so-called wear-and-tear allowance have been

extended by including a new provision, paragraph (ix), which provides that when any ‘qualifying’

asset was used by the taxpayer during any previous year or years for the purposes of a trade

carried on by him and the receipts and accruals of which were not included in his income, the

Commissioner must take into account the period of use of the asset during the previous year or

years in determining the amount by which the value of the assets has been diminished.

Section 12B

Section 12B(4B) has been introduced into the Act to provide that when a ‘qualifying’ asset was

during any previous year brought into use for the first time by the taxpayer for the purposes of a

trade carried on by him, the receipts and accruals of which were not included in his income

during that year, any deduction that could have been allowed will for the purposes of section 12B

be deemed to have been allowed as if the receipts and accruals of the trade had been included in

his income. It should be noted that only ‘farmers’ still qualify for the section 12B allowance.

Section 12C

Section 12C(4A) has been introduced into the Act to provide that when a ‘qualifying’ asset was

during any previous year brought into use for the first time by the taxpayer for the purposes of a

trade carried on by him, the receipts and accruals of which were not included in his income

during that year, any deduction that could have been allowed will for the purposes of section 12C

be deemed to have been allowed as if the receipts and accruals of the trade had been included in

his income.

Section 12C(5) has been amended, to provide that the deductions that may be allowed or are

‘deemed to have been allowed’ in terms of section 12C and section 11(o) in respect of any asset

may not in the aggregate exceed the cost of the asset to the taxpayer.

Section 12D

Section 12D(3A) has been introduced into the Act to provide that when a ‘qualifying’ affected

asset was during any previous year brought into use for the first time by the taxpayer for the

purposes of a trade carried on by him, the receipts and accruals of which were not included in his

income during that year, any deduction that could have been allowed will for the purposes of

section 12D be deemed to have been allowed as if the receipts and accruals of the trade had been

included in his income.

Section 12D(6) has been to provide that the deductions that may be allowed or are ‘deemed to

have been allowed’ in terms of section 12D or any other provision of the Act in respect of the cost

of an affected asset may not in the aggregate exceed its cost.

An amendment has also been made to section 12D(2) which provides for an allowance in respect

of the cost actually incurred by the taxpayer in respect of the acquisition of a new and unused

affected asset that is owned by the taxpayer and brought into use for the first time by him on or

after 23 February 2000 and is directly used by him in the production of his income in carrying on

his sole business of the transportation of persons, goods, things or natural oil or the transmission

of electricity or any telecommunication signal. The term ‘in the production of income’ has been

replaced with the term ‘to the extent that such affected asset is used in the production of income’.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 13

The allowance will therefore be granted to the extent that it is so used. It would seem that the

allowance may be claimed on an apportioned basis on an asset that is used partly for trade

purposes and partly for non-trade purposes. For example, on an electricity or telephone line used

partly for trade and partly for domestic purposes. Another example, is where a pipeline extends

across the Republic border, the section 12D allowance, in these circumstances, will be limited to

the extent that this pipeline is used to produce income that is taxable in the Republic. This

amendment has been backdated to be effective as from 23 February 2000.

Section 13

Section 13(1A) has been introduced into the Act to provide that when a ‘qualifying’ building was

during any previous year or years used by the taxpayer for the purposes of a trade carried on by

him, the receipts and accruals of which were not included in his income during the said year or

years, any deduction that could have been allowed will for the purposes of section 13 be deemed

to have been allowed as if the receipts and accruals of the trade had been included in his income.

Section 13(2) has been amended to limit the deductions that may be allowed under section 13(1)

as well as the allowances ‘deemed to have been allowed in terms of [section 13(1A)]’ in respect

of any building or improvements.

Section 13bis

Section 13bis(3A) has been introduced into the Act to provide that when a ‘qualifying’ building

was during any previous year or years used by the taxpayer for the purposes of a trade carried on

by him, the receipts and accruals of which were not included in his income during the said year or

years, any deduction that could have been allowed will for the purposes of section 13bis be

deemed to have been allowed as if the receipts and accruals of the trade had been included in his

income.

Section 13bis(5) has been amended to limit the total deductions that may be allowed on a

‘qualifying’ building to the actual allowances and any amount ‘deemed to have been allowed in

terms of [section 13bis(3A)]’ to the cost or portion of the cost on which the allowances have been

calculated.

Section 13ter

Section 13ter(6A) has been introduced into the Act to provide that when a ‘qualifying’ building

was during any previous year or years used by the taxpayer for the purposes of a trade carried on

by him, the receipts and accruals of which were not included in his income during the said year or

years, any deduction that could have been allowed in terms of section 13ter will for the purposes

of section 13ter be deemed to have been allowed during the said previous year or years as if the

receipts and accruals of the trade had been included in his income.

The ‘internal’ recoupment provisions as set out in section 13ter(7)(a) are, however, not subject to

this new provision.

Section 13ter(10) has been amended to limit the deductions that may be ‘allowed or deemed to

have been allowed’ under section 13ter to the cost or portion of the cost on which the allowances

have been calculated.

Scrapping allowance

Section 11(o)(bb) has been introduced into the Act to ensure that in the determination of the

scrapping allowance for a ‘qualifying asset’ that was during a previous year or years used by the

taxpayer in the course of a trade carried on by him, the receipts and accruals of which were not

included in his income during the said year or years, account is taken of all the allowances that

could have been made in terms of the various relevant provisions as if the receipts and accruals

had been included in his income.

Recoupments

Integritax Special Issue – March 2001 – Residence Basis of Tax page 14

Section 8(4A) has been enacted to provide that the provisions of section 8(4)(a), (e), (f) or (k) will

not apply in respect of any amount that is deemed to have been allowed as a deduction in terms of

 section 11(e)(ix),

 section 11(o)(bb),

 section 12B(4B),

 section 12C(4A),

 section 12D(3A),

 section 13(1A),

 section 13bis(3A), or

 section 13ter(6A).

These provisions (as set out above) provide the ‘deemed’ allowances. This means that these

deemed allowances are, therefore, not subject to recoupment.

Assessed losses

With the introduction of the world-wide basis of taxation, the reference in section 20(1) to a trade

carried on ‘within the Republic’ has been deleted. This means that the determination of an

assessed loss will now be done on a world-wide basis.

The requirement that the assessed loss be incurred in carrying on a trade ‘in the Republic’ has

also been deleted from the provisions of section 20(1)(b). This provision allows the set off of a

trade loss incurred by the taxpayer during the same year of assessment in carrying on in the

Republic any other trade, either alone or in partnership.

Proviso (b) to section 20(1) has been enacted and it prohibits the set off against the amount

derived by a person from the carrying on of a trade within the Republic of any

69. trade loss incurred by him during the year; or

70. any balance of assessed loss incurred in any previous year of assessment

in carrying on a trade outside the Republic.

As a result of these amendments the following rules will apply.

71. The set off of a ‘foreign’ assessed loss against ‘local’ trade income is prohibited.

72. The set off of a ‘local’ assessed loss against ‘foreign’ trade income is not prohibited.

73. The set off of a ‘foreign’ loss suffered in one ‘foreign’ country against ‘foreign’ trade income

from another ‘foreign’ country is not prohibited.

As a result of the above provisions, losses of foreign branches of a resident company are not

allowed to be set off against its Republic income. This restriction has been made to protect the

existing tax base as there is no information available relating to the magnitude of foreign losses

and to what extent their set off would erode the current South African tax base.

This restriction also limits the possibility of a resident starting a foreign operation in a branch of a

resident company in order to set off its loss against Republic income and then later converting

this branch into a separate subsidiary company when its operations become profitable. If the loss

had been allowed to be set off, it would mean that the income would not be taxed once the entity

showed a profit while the losses previously allowed would have been deductible and would not be

subject to recoupment.

CONVERSION RATE

Republic taxable income is calculated in the currency of the Republic. Foreign receipts and

Integritax Special Issue – March 2001 – Residence Basis of Tax page 15

accruals are unlikely to be in the currency of the Republic – they will therefore have to be

converted into the currency of the Republic. Specific conversion methods are provided in

section 9D (CFE’s), and section 9E (‘foreign’ dividends) which are dealt with later.

As far as other receipts and accruals are concerned a new provision, section 25D deals with the

determination of taxable income or losses in a foreign currency. It provides that the amount of

any taxable income derived by a resident from a source outside the Republic must be determined

in the relevant currency of the country from where the income is derived. The taxable income as

determined in this foreign currency must then be converted to the currency of the Republic on the

last day of the year of assessment. The rate of conversion to be used to determine the Republic

taxable income is the ruling exchange rate on the last day of the year of assessment.

The use of any other exchange rate or rates will be allowed, provided approved by the

Commissioner. This ‘alternative’ exchange rate must take into account the ruling exchange rates

during that year of assessment. The exercise by the Commissioner of his discretion under this

provision (section 25D) is subject to objection and appeal.

No specific provision has been enacted to cover the situation when funds which were blocked

may now be remitted to the Republic (see section 9F(3) in this regard.) It is submitted that in

these circumstances the taxable income of the blocked funds should be determined in the foreign

currency when they actually accrue. This foreign taxable income is then deemed not to be a

receipt or an accrual in the year in which it is actually received or accrued. It is then deemed to be

gross income in the year of assessment when it may be remitted to the Republic. It is then on the

last day of this year of assessment that it must be converted into the currency of the Republic (or

during this year if agreed to by the Commissioner).

Integritax Special Issue – March 2001 – Residence Basis of Tax page 16

Taxes Payable by Foreigners

SOURCE BASIS

The definition of ‘gross income’ reads as follows:

‘“gross income”, in relation to any year or period of assessment, means—

(i) in the case of any resident, the total amount, in cash or otherwise, received by or accrued to

or in favour of such resident; or

(ii) in the case of any person other than a resident, the total amount, in cash or otherwise,

received by or accrued to or in favour of such person from a source within or deemed to be

within the Republic,

during such year or period of assessment, excluding receipts or accruals of a capital nature, but

including, without in any way limiting the scope of this definition, such amounts (whether of a

capital nature or not) so received or accrued as are described hereunder, namely—’.

(Emphasis added.)

From this definition of ‘gross income’ it is clear that South Africa subjects foreigners (persons

other than a resident) to taxation on a source basis.

REPEALED PROVISIONS

As a result of the introduction of the world-wide basis of taxation certain ‘deemed source’

provisions have been repealed. Most of these repealed deemed source provisions applied to

residents, but the following two provisions applied to foreigners.

Contract for the sale of goods made within the Republic

Section 9(1)(a) which applied to amounts derived by virtue of a contract made within the

Republic for the sale of goods, whether they have been or are to be delivered in or out of the

Republic, has been repealed.

As residents who sold goods would have been had the proceeds from the sale included in their

gross income on the basis that they were trading in the Republic or because the true source of the

resulting income was in the Republic, it is likely that the provisions of section 9(1)(a) effectively

applied only to foreigners.

Although this provision deemed the proceeds from the sale of the goods to be from a Republic

source, it is unlikely that these amounts were ever taxed in the Republic. Most of South Africa’s

double taxation agreements with other countries, provide that residents of the other countries are

exempt from South African tax on trading profits unless they are derived from a permanent

establishment in South Africa. The conclusion of a contract of sale in the Republic and a deemed

inclusion in Republic gross income were therefore insufficient to cause a liability for tax on the

foreigner who did not have a permanent establishment in the Republic.

It would therefore seem that the repealing of this provision is not likely to cause a loss of earnings

to the fiscus.

Royalties and know-how

Section 9(1)(b) which applied to amounts derived from the use or right of use in the Republic of,

or the grant of permission to use in the Republic, a patent, design, trade mark, copyright, model,

pattern, plan, formula, or process or any other property or right of a similar nature, any motion

picture film, film or video tape or disc for use in connection with television, or any sound

recordings or advertising matter used or intended to be used in connection with the motion picture

film, film or video tape or disc, has been repealed.

Section 9(1)(bA) which applied to amounts derived from the imparting or the undertaking to

impart certain know-how for use in the Republic has also been repealed.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 17

The repealing of section 9(1)(b) and (bA) does not mean that foreigners will not be taxed on the

royalties they earn from the Republic. These royalties are no longer liable for normal tax but are

now liable for the special ‘withholding tax on royalties’ payable by foreigners (see below in this

regard).

TYPES OF RECEIPTS AND ACCRUALS

A non resident may have the following types of receipts or accruals from a Republic source (true

or deemed):

74. ‘Local’ dividends.

75. Interest.

76. Rentals.

77. Royalties.

78. Pensions.

79. Annuities.

80. Director’s fees.

81. Business profits (or losses).

82. Services rendered or work done for the Government.

DIVIDENDS

True source

In Boyd v CIR 1951 (3) SA 525 (A), 17 SATC 366 it was held that the true source of dividends is

the shares giving rise to the dividends. The situation of shares is where they are registered, that is,

where they can be effectively dealt with. The source from which the company derives its income

is irrelevant. From this judgment in Boyd’s case it follows that the legal situation of the register of

shareholders of the company determines the location at which the shares are situated. And

because all companies registered in South Africa are compelled to keep their register of

shareholders in the Republic, the shares of all South African companies must be regarded as

being registered in the Republic.

In terms of Boyd’s case, therefore, a dividend received from a company incorporated in the

Republic that derives all its income from sources outside the Republic is from a South African

source, while a dividend received from a company incorporated in a foreign country that derives

all its income from South African sources is from a source outside the Republic.

Deemed source

Paragraph (k) of the definition of ‘gross income’ includes in the income of a resident any amount

received or accrued by way of dividends including foreign dividends. Paragraph (k) is of no effect

to a non resident, since its provisions apply only to a resident.

Exemption

Section 10(1)(k) provides that most ‘local’ dividends received by or accrued to a taxpayer are

exempt from normal tax. A non resident will include in his gross income the ‘local’ dividends that

accrue to him. But these dividends are then exempt from taxation. And because he is not a

resident, ‘foreign’ dividends are not deemed to accrue to him.

INTEREST

Source

A non-resident taxpayer may be liable for Republic normal tax on the interest that he has earned

from Republic sources. It is only when the interest is neither from a true Republic source nor

Integritax Special Issue – March 2001 – Residence Basis of Tax page 18

from a deemed Republic source or when it is exempt from normal tax in the Republic that the

interest will be tax free in the Republic.

The position is that interest on a loan (or investment) will be included in the lender’s gross

income (and possibly liable to normal tax depending upon possible exemptions or the amount of

interest which accrued during the year) if it has its source (true or deemed) in the Republic, no

matter to whom it is paid or where the recipient might reside.

True source

In CIR v Lever Bros & Unilever Ltd 1946 AD 441, 14 SATC 1 it was held (by the majority) that

the source or originating cause of interest payable on a loan of money was not the debt but the

services that the lender performs to the borrower, namely, the supply of credit, in return for which

the borrower pays him interest.

An investor in interest-bearing securities is in all respects the same as a lender of money as he is

paid for the services that he performs to the borrower, being the supply of credit. Thus the true

source of interest from an interest-bearing security is, in terms of the Lever Bros case, also the

provision of the credit. This would be the place where the money for the investment was actually

handed over. Therefore non residents making investments in interest-bearing securities in the

Republic will cause the resulting interest to be from a Republic source.

Deemed source

Section 9(6) deems the source of interest to be in the Republic

‘where such interest was derived from the utilisation or application in the Republic by any

person of any funds or credit obtained in terms of any form of interest-bearing arrangement’.

Section 9(7) provides that the place of use or application of the funds shall, unless the contrary is

proved, be deemed to be, in the situation where these funds are used or this credit is applied by

83. a natural person, the place where such person is ordinarily resident; or

84. a person other than a natural person, its place of effective management.

Although the interest may be included in the non resident’s gross income it

could then be exempt from taxation under either section 10(1)(h),

10(1)(hA), or 10(1)(i)(xv) (see below).

Exemption – ESKOM and similar stocks

Certain interest accruing to a taxpayer who is not a resident of the Republic and who does not

carry on business in the Republic is exempt from normal tax. The interest must accrue from

certain qualifying investments. The qualifying investments are ‘stock or securities (including

Treasury Bills [these are now called Exchequer Bonds elsewhere in the Act]) issued by the

Government including the South African Transport Services, or any local authority within the

Republic or the Electricity Supply Commission [ESKOM] or the South African Broadcasting

Corporation’.

Investments qualifying for the section 10(1)(h) exemption have for many years been a popular

investment for ‘blocked funds’ of previous residents of the Republic who have left this country to

live elsewhere. See, for example, SIR v Downing (4) SA 518 (A), 37 SATC 249.

Although this exemption was designed to encourage foreign investment in the Republic, see the

Explanatory Memorandum on the 1990 Income Tax Bill, its wording permits an emigrant to

invest his ‘blocked funds’ in the relevant tax-free investment.

Exemption – all interest

Interest accruing on or after 3 June 1992 from a Republic source (from any type of interestbearing

security) to a taxpayer who is not a resident will be exempt from normal tax in terms of

Integritax Special Issue – March 2001 – Residence Basis of Tax page 19

section 10(1)(hA). Any person who is a resident of

‘any country which has for the purposes of applying any regulation made under section 9 of the

Currency and Exchanges Act, 1933 (Act 9 of 1933), been included in the common monetary

area’

– ‘the extended Republic’ is deemed to be a resident of the Republic.

Therefore non residents may be able to earn interest from Republic sources completely free of

Republic tax. (They may, of course, be taxed on this interest in their country of residence.)

Republic emigrants also qualify for this exemption, with the result that ‘blocked funds’ can be

invested in interest-bearing securities in the Republic tax free. (An emigrant in this context is a

taxpayer who at some stage in his life was a resident of the Republic.) But there is an important

proviso which controls the exemption in respect of interest accruing to non residents who are

Republic emigrants.

This exemption will be available only in a year of assessment in which the emigrant did not carry

on business in the Republic. Therefore the taxation or exemption from tax of the emigrant on his

interest accruals hinges on the answer to the question of whether or not he carried on business in

the Republic during the year of assessment.

85. If he did, he will be taxed on the interest.

86. And if he did not, his interest will be exempt from taxation.

In the year of emigration, it is likely that in most situations the emigrant would have carried on

business in the Republic prior to his emigration, with the result that the exemption will not be

available. From the following year of assessment it could become exempt.

Each year of assessment must be examined on its own. And if the taxpayer fails the test in one

year, this failure on its own, does not disqualify him in the next year of assessment.

A crucial issue in relation to emigrants is therefore the question of what the term ‘carrying on

business’ in the Republic means. In this regard it should be noted that although the earning of a

salary constitutes the carrying on of a ‘trade’ as defined it is unlikely to amount to the carrying on

of a business.

Carrying on business

The courts have held that several factors should be looked at in deciding whether a taxpayer is

carrying on business in the Republic. In this regard the following are relevant:

87. The degree of continuity.

88. The profit-making motive.

89. The frequency of the business.

90. The facts surrounding the matter.

The decision in CIR v Kuttel 1992 (3) SA 242 (A), 54 SATC 298 indirectly confirmed that

attending a directors’ meeting does not constitute carrying on a business. In the lower court,

reported as ITC 1501 (1989) 53 SATC 314, Howie J held that the taxpayer (Kuttel) was not

carrying on business in the Republic. The Commissioner, who appealed against this judgment,

only appealed on the issue of the taxpayer being ‘ordinarily resident’ in the Republic. In effect,

therefore, the Commissioner, by not appealing on the issue of ‘carrying on business’, must have

accepted that Kuttel’s attending of directors’ meetings did not amount to him carrying on a

business.

In ITC 1529 (1991) 54 SATC 252 the court had to decide whether an emigrant was carrying on

business in the Republic in order to determine whether he was entitled to certain exemptions on

the interest and dividends that had accrued to him. He owned and derived rentals from a single

Integritax Special Issue – March 2001 – Residence Basis of Tax page 20

lettable unit let to a tenant for several years. The court held that the letting of property would

constitute the carrying on of business only if there was a system or plan disclosing a degree of

continuity or regularity in the operation. But as far as this taxpayer was concerned the letting did

not amount to the carrying on of business. It was an investment in property with the rentals

merely being the return from this investment, with the result that the taxpayer was not carrying on

business in the Republic.

The 183-day requirement

Section 10(1)(h) and (hA) (see above) provides exemptions for interest derived by a person who

is not a resident of the Republic. To qualify for both these exemptions investors in interestbearing

securities must, in addition to being not a resident of the Republic, have been physically

absent from the Republic for at least 183 days during the year of assessment in which the interest

accrues.

This so-called 183-day requirement applies to all non residents and not merely to those who were

at one time residents of the Republic. ‘Genuine’ non residents who visit the Republic would

therefore find that the interest they earn from Republic sources would be taxable if they end up

being present in the Republic for more than 183 days (184 days in a leap year) in a year of

assessment because they would not have been

‘physically absent from the Republic for a period or periods of at least 183 days in the

aggregate during the year of assessment’.

Section 10(1)(h) exempts from tax certain interest received by or accrued to any person (other

than a company) who is not a resident and who does not carry on business in the Republic or any

company which is not a resident and which does not carrying on business in the Republic. The

exempt interest is that derived from stock or securities (including Treasury Bills) issued by the

Government, including SATS, any local authority within the Republic, ESKOM or SABC (see

above).

Section 10(1)(hA) exempts interest received by or accrued to a person who is not a resident of the

Republic. One of the differences between this exemption and that provided by section 10(1)(h) is

that this exemption is not limited to interest derived on qualifying stocks and securities and so is

much wider in its scope (see above).

Its first proviso denies the exemption to a natural person who was formerly a resident of the

Republic (an ‘emigrant’) if he carried on business in the Republic during the year of assessment.

The ‘183-day’ requirement does not come as an extension to this first proviso, but as an entirely

separate proviso – being the fourth proviso to this exemption. It makes the exemption unavailable

to a natural person unless he was physically absent from the Republic for a period or periods of at

least 183 days in the aggregate during the year of assessment in which the interest was received or

accrued. By making this ‘183-day’ requirement a separate proviso it applies not only to the

‘emigrant’ (the first proviso) but to all non residents.

As pointed out above, visitors on extended excursions to the Republic will need to carefully plan

their trips to ensure they do not forego both the section 10(1)(h) and section 10(1)(hA)

exemptions. Favourable flight excursions which cause the visitor to be in the Republic for more

than 183 days (184 days in a leap year) in a year of assessment will have to be avoided if the

visitor would like to enjoy these exemptions.

Should the ‘183-day’ provisos come into operation to deprive the non resident of the

section 10(1)(h) and (hA) exemptions, he will still qualify for the section 10(1)(i)(xv) exemption

– the exemption in respect of the first R3 000 (or R4 000 for taxpayers who have attained the age

of sixty-five years) of not otherwise exempt dividends or interest. But this ‘basic’ R3 000 (or

R4 000) exemption is of small consolation since an unlimited amount of interest may be exempt

under the provisions of section 10(1)(h) and (hA).

Integritax Special Issue – March 2001 – Residence Basis of Tax page 21

The following example illustrates the effect of the loss of the section 10(1)(hA) exemption caused

by an excessive stay (over 183 days) in the Republic.

Data

A taxpayer emigrated from the Republic six years ago, a few months after her husband died. She

is now not a resident of the Republic as defined. She invested her blocked funds in an interestbearing

security, ‘local’ dividend-yielding shares and a rent-producing property. In the 2002 year

of assessment she expects to earn the following amounts from these investments. She has attained

the age of sixty-five years.

 Interest of R90 000.

 ‘Local’ dividends of R30 000.

 Net rentals of R60 000.

She visited friends in the Republic from 1 January 2001 to 30 April 2001. She is planning to visit

the Republic again in order to attend a grandson’s wedding which will take place in December.

An airline is offering a special discount return flight on a four-month return trip. She can either

take the flight that arrives in the Republic on

 1 October 2001 and leaves the Republic on 31 January 2002, or

 1 November 2001 and leaves the Republic on 28 February 2002.

Solution

The taxpayer has already spent sixty-one days (March and April) in the Republic in the 2002 year

of assessment. The October-January trip will cause her to stay in the Republic for another

123 days while the November-February trip will cause her to stay in the Republic for another

120 days. The October-January trip results in her being in the Republic for 184 days and out of

the Republic for 181 (365 – 184) days. The November-February trip results in her being in the

Republic for 181 days and out of the Republic for 184 (365 – 181) days.

To qualify for the section 10(1)(hA) exemption she must be out of the Republic for at least

183 days.

Her resulting Republic normal tax liabilities will be as follows:

October–Janu tarripy November–Februtarripy

Interest 90 000 90 000

Less exempt portion 4 000 86 000 90 000 –

‘Local’ dividends 30 000 30 000

Less exemption (in terms of section 10(1)(k)) 30 000 – 30 000 –

Net rentals 60 000 60 000

Taxable income 146 000 60 000

Schedule tax payable

On base 17 400 13 700

On excess 30 400 –

Integritax Special Issue – March 2001 – Residence Basis of Tax page 22

Normal tax payable 47 800 13 700

Less rebate 3 800 3 800

She saves R34 100 (R44 000 – R9 900) in her normal tax liability by taking the November-

February flight as opposed to the October-January flight.

RENTALS

True source of rentals from immovables

The true source of a rental from an immovable property will be at the place where it is situated

because it is the giving of its use which earns the rental. In Rhodesian Metals Ltd v COT 1938

(AD) 282, 9 SATC 363, the court came to the conclusion that the true source of the profits in

question was the immovable property which was acquired and developed for the purpose of

obtaining the profit. In this case the court was dealing with the profits derived from the sale of

immovable property.

True source of rentals from movables

Neither the place where the contract of letting is entered into nor the place where the let asset is

used is conclusive as to the location of the true source of rentals from the use of movables. The

originating cause of the rental is either

91. the use of the property, or

92. the business activities of the lessor.

The nature of the movable and the duration of its use by the lessee may help decide the issue.

93. If the true source is the business activities of the lessor, then it is located where these activities

are carried on.

94. If the true source is the use of the movable then all the circumstances must be examined to

determine whether the true source is at the place where the moveable is let or where it is used.

For example, if the asset is let in the Republic and the hirer is free to use it world-wide, the

true source would be in the Republic. If, however, it is let to be used solely at a particular

place, then its true source would be at that particular place.

Deemed source

There are no deemed source provisions that relate to rentals earned by a non resident.

Exemptions

There are no exemption for non residents in respect of rentals they have earned from a Republic

source.

Conclusion

A non resident who invests in a rent-producing property in the Republic will be subject to

Republic normal tax on the net rentals he earns. As far as moveable assets are concerned, if one

of a non resident’s moveable assets is used solely by a lessee in the Republic, he will be subject to

Republic normal tax on the net rentals he earns from it.

ROYALTIES

Royalties will be included in Republic gross income if they are from a Republic true source. It is

therefore necessary to first establish where the true source of the royalty is. If the true source is in

the Republic, then the entire royalty (100%) must be included in the non resident’s gross income.

Any expenses incurred in producing this income, provided not of a capital nature, may be

Integritax Special Issue – March 2001 – Residence Basis of Tax page 23

deducted from this gross royalty.

If the true source of the royalty is outside the Republic, but it results from the use of a royaltyproducing

asset in the Republic, then the gross royalty is subject to the withholding tax on

royalties. Section 35 subjects the gross royalty to a ‘final’ tax of 12% (see below). Therefore no

deductions are made against the amount of this royalty.

True source

In Millin v CIR 1928 (AD) 207, 3 SATC 170, it was held that the true source of royalties accruing

from a book was the author’s wits, labour and intellect. Therefore if these activities are carried

out in the Republic, the true source is in the Republic. The principle from Millin’s case also

applies to royalties accruing to inventors from patents and similar assets. If the inventor applies

his wits, labour and resources in the Republic, any resulting income accruing to him is from a true

source in the Republic.

When a royalty is earned by a person who is not the original author or inventor, for example, by a

person who has purchased the royalty-producing asset from the original author or inventor, since

the royalties would then be derived not from the wits, labour or intellect of the recipient but from

the ownership of the royalty-producing asset, the true source of the royalty would be where the

purchaser employed his capital when he purchased the royalty-producing asset.

Deemed source

With the introduction of the world-wide basis of taxation, royalties are no longer deemed to be

from a Republic source.

Exemptions

Section 10(1)(m) exempts from tax a royalty to an author in respect of a copyright if the royalty if

95. it is subject to a non-fundable income tax in a country other than the Republic, and

96. provided he is the first owner of this copyright.

This exemption is, however, not available to a company taxpayer.

Section 10(1)(l) exempts from normal tax a royalty that is subject to the withholding tax on

royalties (see below).

Conclusion

It is therefore only when the true source of a royalty (other than a copyright royalty) is in the

Republic that a non resident will be subject to normal tax in the Republic on the royalty. When

this occurs, he will be taxed on the net amount of this royalty. It would seem that this situation is

likely to apply to an emigrant (an author or an inventor who wrote or created the royaltyproducing

asset is in the Republic). But then royalties that accrue to a non resident for the use of

the royalty-producing asset in the Republic are subject to the withholding tax on royalties (in

terms of section 35). And when this occurs the royalty is then exempt from normal tax (in terms

of section 10(1)(l). The combined effect of all these provisions would seem to be as follows:

97. When the true source of a royalty is in the Republic and royalties accrue to the non-resident

owner of the royalty-producing asset from its use in the Republic, these royalties will be

subject only to the withholding tax on royalties.

98. When the true source of a royalty is in the Republic and royalties accrue to the non-resident

owner of the royalty-producing asset from its use outside the Republic, these royalties will be

subject only to normal tax.

It would seem that the above conclusion will not apply when the owner of the royalty-producing

asset is a branch or an agency of a non-resident company trading in the Republic.

The provisions of section 35 (see below) do not apply to a non-resident company, if the royalty is

Integritax Special Issue – March 2001 – Residence Basis of Tax page 24

derived by the company from a trade carried on through a branch or agency in the Republic and is

subject to tax in the Republic. A branch or agency of a non-resident company trading in the

Republic that is subject to tax in the Republic would have had a Republic taxable income because

its receipts and accruals would be from a Republic source – being a non resident it is taxed on a

source basis. To have a royalty included in its gross income this royalty must be from a Republic

true or deemed source. As it is unlikely that a branch or agency of a non-resident company could

be an author or inventor of the royalty-producing asset it must have purchased the royaltyproducing

asset for the true source provisions apply. The non-resident company must therefore

own the rent-producing asset and it must be using it in its Republic branch or agency to earn

royalties for its use in the Republic. In this situation the non-resident company will be subject to

normal tax and not the withholding tax on royalties on this royalty. And it will be taxed on the net

royalty earned.

PENSIONS

True source

It would seem that it is the practice of the Commissioner to apply the deemed source provisions

of section 9(1)(g) to all pensions, irrespective of their true source, and to include in Republic

gross income only those pensions to which the provisions of section 9(1)(g) apply. In other

words, the true source provisions of a pension are disregarded and only the deemed source

provisions apply. In this regard, refer to the ‘Information Brochure for Individuals

(Form IT 38P)’.

Deemed source

Government pensions

Section 9(1)(g)(i) deems a ‘government’ pension or annuity to be derived by a person from a

source in the Republic if it has been received by or has accrued to him or in his favour by virtue

of any pension or annuity granted to him by

99. the Government,

100. a provincial administration, or

101. a local authority

in the Republic, no matter where payment is made or the funds from which payment is made are

situated or his services have been rendered.

Non-Government pensions

Section 9(1)(g)(ii) deems a pension granted by any person, whether residing or carrying on

business in the Republic or not, if the services in respect of which the pension was granted were

performed within the Republic for at least two years during the ten years immediately preceding

the date from which the pension first became due to be from a Republic source.

It then provides for an apportionment if the pension was granted in respect of services that were

rendered partly within and partly outside the Republic. The portion of the pension which bears to

the amount of the pension the same ratio as the period during which the services were rendered in

the Republic bears to the total period during which the services were rendered is deemed to be

from a source within the Republic.

These deemed source provisions relating to ‘local’ pensions apply to both residents and non

residents.

Exemption

There is no exemption available to a non resident in respect of pensions from a Republic true or

deemed source.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 25

Conclusion

A non resident who enjoys a pension from the South African Government (or a semi-government

body) will be subject to Republic normal tax on this pension.

A non resident who enjoys a ‘non-governmental’ pension will be subject to Republic normal tax

only if the services in respect of which the pension was granted were performed within the

Republic for at least two years during the ten years immediately preceding the date from which

the pension first became due. It is likely therefore that this provision will apply only to an

‘emigrant’.

ANNUITIES

True source

The true source of an annuity is its underlying contract. A contractual annuity will therefore be

from a Republic source if the contract is made in the Republic because the contract is its

originating cause.

In the situation of a purchased annuity, being an annuity purchased from an insurer, the

Commissioner regards the true source of the annuity at the place where the contract, in terms of

which the insurer undertook to pay the annuity, was entered into. The place where the contract

was accepted by the insurer is therefore the location of its true source.

Deemed source

There are no deemed source provisions that apply to deem an annuity which has its true source

outside the Republic to be from a Republic source when it accrues to a non resident.

Exemption

No exemption from normal tax is available in respect of contractual annuities. (In fact, because an

annuity’s inclusion in gross income is in terms of paragraph (a) of the definition of ‘gross

income’, even an annuity that is capital in nature is taxable.) As far as ‘purchased’ annuities are

concerned, the portion of the annuity that is capital in nature is exempt from normal tax in the

Republic (in terms of section 10A).

Conclusion

A contractual annuity that has its true source in the Republic and which accrues to a non resident

will be subject to Republic normal tax. And the ‘income’ portion of a ‘purchased’ annuity that has

its true source in the Republic and which accrues to a non resident will be subject to Republic

normal tax.

DIRECTORS’ FEES AND SALARIES

True source

The true source of a director’s services (as a director) is regarded as being rendered at the head

office of the company where the board of directors ordinarily transacts its business. Therefore if

the head office of the company is in the Republic, the directors’ fees are derived from a Republic

true source, irrespective of the place
where the director resides and performs the services.

A director who is not a resident of the Republic would therefore be liable for Republic normal tax

on his fees if the board of directors meets in the Republic. Yet a director who is not a resident of

the Republic may be paid a fee for services rendered outside the Republic as a member of a local

board or committee set up outside the Republic. In this situation the fee is not derived from a

Republic source.

A director may also render services for his company in a capacity other than that of director, for

example, he may manage the day-to-day affairs of a company or assist the company in other ways

on a full-time basis. The source of the earnings of a director who holds a salaried appointment

Integritax Special Issue – March 2001 – Residence Basis of Tax page 26

must be at the place where he renders these services. If a director who is not a resident of the

Republic renders these types of services in the Republic, even if only for a portion of a year of

assessment, the salary he earns for these services will be from a Republic source.

Deemed source

There are no provisions that deem directors’ fees and salaries to be from a Republic source when

they accrue to a non resident for rendering services outside the Republic.

Exemption

There are no provisions that exempt directors’ fees and salaries from Republic normal tax when

they accrue to a non resident for rendering services outside the Republic.

Conclusion

A non-resident director will be subject to normal tax in the Republic if he is a ‘head-office’

director and the head office of the company is situated in the Republic. And he will be liable for

Republic normal tax on any salary he earns when performing certain services in the Republic for

the company.

INCOME FROM ACTIVITIES IN THE REPUBLIC

Agents

The true source, being the originating cause of a commission or other similar earnings derived by

agents or representatives, is the service for which the commission and similar earnings are paid.

This will be located at the place where the service is rendered. Therefore a non resident earning a

commission (or similar earnings) for rendering services in the Republic will be subject to

Republic normal tax on this commission (or similar earning).

Employment and services rendered

The true source or originating cause of income from employment and other services rendered is

the services, irrespective of the place where the contract is made or the earnings are paid. The true

source of the earnings would be at the place where the services are rendered. Therefore a non

resident earning an amount (a fee or remuneration) for rendering services in the Republic will be

subject to Republic normal tax on this amount.

Partnership activities

In CIR v Epstein 1954 (3) SA 689 (A), 19 SATC 221 the Appellate Division of the Supreme Court

(now the Supreme Court of Appeal) found that when there is a partnership the members of which

carry on their business activities in two different countries, the income of the partnership is

derived from two sources. When one of the partners carries on his business activities in the

Republic his income from the partnership has its true source in the Republic, while the income of

the other partner is from a source outside the Republic. The income that the partner who carries

on his business activities in the Republic is therefore subject to normal tax in the Republic.

Other business activities

A non resident carrying on a business in the Republic will be trading in the Republic and the

receipts and accruals of this business will have their true source in the Republic. The ‘activities’

test from Epstein’s case will apply and the business activities will be taking place in the Republic.

Any resulting profit from the business or trade will be subject to normal tax in the Republic. Any

resulting loss will either be

102. deductible from other taxable earnings from Republic sources (true or deemed) or if there

are no other Republic taxable earnings,

103. carried forward as an assessed loss to be deducted in the next year of assessment.

The above situation will apply to a natural person who is not a resident of the Republic and to a

Integritax Special Issue – March 2001 – Residence Basis of Tax page 27

non-resident company. It is likely that a non-resident company will be trading or carrying on

business in the Republic through the means of either a branch or an agency. A special rate of

corporate tax applies to these entities.

Branch profit tax rate

The rate of ‘branch profits tax’ on the taxable income derived by a company that has its place of

effective management outside the Republic and who carries on a trade through a branch or agency

within the Republic is 35%. Taxable income subject to this tax is expressly excluded from the

taxable income subject to the normal tax rate of 30%.

STC

Dividends declared by a ‘branch’ of a company that is not a resident of the Republic out of

certain profits derived through a branch or agency are not liable for STC.

GOVERNMENT SERVICES

True source

When services are rendered to the South African Government they may be rendered in or outside

the Republic. If they are rendered in the Republic then the true source of the amount paid for the

services rendered is in the Republic. If they are rendered outside the Republic then the true source

of the amount paid for the services rendered is outside the Republic. But when the true source of

the amount earned for services rendered is outside the Republic, then the deemed source

provisions of section 9(1)(e) will apply to the amount earned and deem it to be from a Republic

source.

Deemed source

Section 9(1)(e) applies to services rendered or work or labour done for or on behalf of any

employer in the

national or provincial sphere of government,

any local authority in the Republic, or

any national or provincial public entity if not less than 80% of its expenditure is defrayed directly

or indirectly from funds voted by Parliament.

Section 9(1)(e) applies to services rendered or work or labour done outside the Republic, as long

as the services are rendered or the work or labour is done in accordance with a contract of

employment entered into with the Government or ‘semi-government’ entity.

The proviso to section 9(1)(e) provides that its provisions must not be construed as imposing

liability for tax on any payment made to a person stationed outside the Republic by way of an

allowance for the purpose of meeting expenditure incurred by him in connection with his official

duties outside the Republic. But excluded from this concession are allowances for the purpose of

meeting domestic or private expenditure. These allowances are therefore taxable in the Republic

(but see below for a possible exemption in terms of section 10(1)(p)).

It should be noted that the provisions of section 9(1)(e) no longer specifically apply to services

rendered to the South African Tourist Corporation (SATOUR) and the Council for Scientific and

Industrial Research (CSIR). But if these institutions meet the ‘80% funding’ by the Government

requirement their employees will be subject to these provisions.

Exemption

Section 10(1)(p) exempts amounts derived by a person referred to in section 9(1)(e) from normal

tax if he is not a resident of the Republic and is chargeable with income tax in the country in

which he is ordinarily resident. This tax must be borne by the person himself and must not be paid

on his behalf by his Government, local authority, or a public entity.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 28

Conclusion

A non resident working for the South African government or a semi-government body will be

subject to normal tax on the amount he earns from it. Only when he is personally liable to pay tax

on this same amount in the country where he is ordinarily resident, will he be exempt from

Republic normal tax on this amount.

PERSONAL REBATES

As a result of being entitled to rebates, non-resident taxpayers only become liable for the payment

of normal tax in the Republic once their taxable incomes exceed a certain amount – this amount

being referred to as the particular taxpayer’s tax threshold. A natural person under sixty-five years

old must earn an annual taxable income in the 2001 year of assessment in excess of R21 111

before becoming liable for the payment of normal tax. The corresponding amount for natural

persons over sixty-five years old, is a taxable income exceeding R36 538.

These two tax thresholds for normal tax purposes can be used to advantage by non-resident

taxpayers. They could, for example, invest in rent-producing properties situated in the Republic

and obtain net rentals completely tax free (in the Republic). This will happen if the net rentals

earned do not exceed the non residents threshold for normal tax purposes. On this basis, a non

resident under the age of sixty-five years could earn net rentals from a Republic source of

R21 111 a year before becoming liable for any Republic taxation (R36 538 for non residents who

have attained the age of sixty-five years).

WITHHOLDING TAX ON ROYALTIES

Taxable amount and liability

Section 35(1) applies to a non resident by whom an amount is received or to whom an amount

accrued by virtue of

the use or right of use in the Republic of, or the grant of permission to use in the Republic, a

patent, design, trade mark, copyright, model, pattern, plan, formula, or process or any other

property or right of a similar nature, or any motion picture film, film, or video tape, or discs

for use in connection with television, or any sound recording or advertising matter used or

intended to be used in connection with the motion picture film, film or video tape or disc,

wherever the property has been produced or made, the right of use or permission has been

granted, payment for the use, right of use or grant of permission has been or is to be made and

whether the payment has been or is to be made by a person resident in or outside the Republic;

or

the imparting or the undertaking to impart any scientific, technical, industrial or commercial

knowledge or information for use in the Republic, or the rendering of or the undertaking to

render, any assistance or service in connection with the application or use of the knowledge or

information, wherever the knowledge or information has been obtained or has been or is to be

imparted or the assistance or service has been or is to be rendered or the undertaking has been

given, and whether payment has been made or is to be made by a person resident in or outside

of the Republic.

(The above amounts to which the provisions of section 35(1) apply were the amounts that were

previously deemed to be from a Republic source in terms of section 9(1)(b) and (bA).)

These amounts are liable to a ‘final’ tax to be known as the withholding tax on royalties, which

will be levied at a rate of 12%.

Prior to 1 January 2001, section 35(1) applied to the same amounts but the 12% levied was

simply an ‘advance’ towards the non-resident taxpayer’s normal tax liability. If this ‘advance’

exceeded his normal tax liability then any excess would have been refundable to the non resident

either an assessment or under the provisions of section 102.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 29

104. As the effective corporate rate of normal tax on royalties earned by non-resident

companies would have been 9% (30% of 30%) an overpayment would have resulted from a

provisions of section 35(1).

105. In the situation of the non-resident natural person the effective rate of normal tax on

royalties earned would have ranged from 0% (0% of 30%) to 12,6% (42% of 30%).

Overpayments would therefore have occurred in most circumstances.

It must be noted that this withholding tax on royalties is a final tax and not an advance payment

towards normal tax.

Exemptions

The withholding tax on royalties will not apply to an amount which is received by or accrues to

a company that is not a resident, if the amount is derived by the company from a trade carried on

through a branch or agency in the Republic and is subject to tax in the Republic; or

a person (other than one whose place of residence is in a neighbouring country) in respect of the

use (otherwise than for advertising purposes in connection with a motion picture film or

otherwise than in connection with television) in any printed publication of any copyright.

A branch or agency of a non-resident company trading in the Republic that is subject to tax in the

Republic would have had a Republic taxable income because its receipts and accruals would be

from a Republic source, being a non resident, it is taxed on a source basis. As this branch or

agency would then be liable for Republic normal tax on its royalty receipts and accruals it will be

exempt from the withholding tax on royalties on these royalty receipts and accruals.

South Africa did not in the past subject to tax royalties from printed publications that accrue to

foreigners. By making royalties of this nature now exempt from the withholding tax on royalties

this policy of not taxing these ‘copyright’ royalties continues under the world-wide basis of

taxation.

Amount

In terms of section 35B(1) it is the gross royalty that is subject to the withholding tax on royalties

at 12%. Because the gross amount is subject to the tax no expenses incurred in producing the

royalty will be tax deductible.

Collections

Section 35(2) provides the method that is used for the collection of the withholding tax on

royalties. It applies when a person (the royalty user) incurs a liability to pay a royalty to another

person

who is not a resident, or

who receives payment of the royalty on behalf of a non resident (an agent).

This payment is a ‘final payment’ in respect of the other person’s (the owner of the royaltyproducing

asset) liability for the withholding tax on royalties.

Relief

In terms of section 35(2)(a)(i) the Commissioner may relieve the person who is required to make

the tax payment (the royalty user or the agent) from the obligation to do so if he is satisfied that

the tax payment required to be made in terms of this provision has been or will be made by any

other person. A decision made by the Commissioner in the exercise of his discretion under this

provision is subject to objection and appeal.

Deemed foreigners

In terms of section 35(B(2)(a)(ii) a person having an address outside the Republic will, until the

Integritax Special Issue – March 2001 – Residence Basis of Tax page 30

contrary is proved, be deemed not to be a resident.

Right of recovery

In terms of section 35(2)(b) the person paying the tax (the royalty user or the agent) is entitled,

notwithstanding any agreement between the parties, to deduct the withholding tax on royalties

from the royalty he is liable to pay to the taxpayer or his agent, or

to recover the withholding tax on royalties paid from the taxpayer or his agent, or

to retain out of any money that may be in his possession or which may come to him as an agent

for the taxpayer an amount equal to the withholding tax on royalties paid or payable.

General provisions

In terms of section 35(2)(c) the general provisions of Parts I to VI of the Act will mutatis

mutandis apply to the payment of the withholding tax on royalties.

No recovery

In terms of section 35(2)(d) the taxpayer (the owner of the royalty-producing asset) on whose

behalf the payment of the withholding tax on royalties has been made is not entitled to recover the

amount of the tax paid from the person who deducted, withheld or retained it (the royalty user or

the agent). He is deemed to have received the amount deducted or withheld.

Liability

In terms of section 35(2)(e) the payer of the royalty (the royalty user) or the recipient of the

royalty on behalf of the non-resident person (the agent) is personally liable for making the

payment of tax, and the amount payable is deemed to be a tax due by the payer (the royalty user)

or recipient (the agent) and is recoverable from him.

Return of income

In terms of section 35(2)(f) the owner of the royalty-producing asset (the non resident) is obliged

to render a return of income for the year of assessment and to pay the withholding tax on royalties

for which he is liable. The tax deducted from the gross royalty will be set off against his total tax

payable for the year,

any underpayment being recoverable from him, and

any overpayment being refunded to him.

His right to claim a refund of any tax overpaid by him in terms of section 102 is confirmed. Yet

as the amount deducted from the gross royalty is now a ‘final’ tax it must be equal to the non

resident’s liability for the withholding tax on royalties. It is therefore not clear why the provisions

of section 35(2)(f) have been retained.

Exemption from normal tax

Section 10(1)(l) has been brought into the Act to exempt from normal tax an amount received by

or accrued to a person that is subject to the withholding tax on royalties.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 31

Tax Liability of a Resident

INTRODUCTION

Because world-wide receipts and accruals have been included in this taxable income calculation,

certain amounts from a foreign source included therein may have already been subjected to tax in

a foreign country.

It is the before-tax amounts of these foreign receipts and accruals that are included in Republic

gross income. Taxes paid in these countries, which would include various withholding taxes, are

not allowed as a tax deduction in the determination of taxable income (although their deduction is

not prohibited in terms of section 23(d), it is submitted that they will fail to pass the general

deduction formula, being the only provision under which their deduction could be considered).

An election is available to a resident to be taxed on the after-tax amount of a ‘foreign’ dividend.

To give relief to the resident who has been taxed twice on the same receipt or accrual, a credit is

given against his Republic normal tax liability in the form of the section 6quat rebate (see below).

SECTION 6QUAT

Section 6quat is the provision that provides the credit relief. It splits into the following

provisions.

106. Section 6quat(1) identifies the receipts and accruals which give rise to the rebate.

107. Section 6quat(1A) determines the amount of the rebate.

108. Section 6quat(1B) places a limit on the amount that may be set off in the current year of

assessment and allows any excess to be carried forward to the next year of assessment.

109. Section 6quat(2) ensures that double relief does not result through relief under a double

tax agreement and section 6quat.

110. Section 6quat(3) gives the definition of four terms.

111. Section 6quat(4) provides the method to be used to convert the foreign taxes paid into the

currency of the Republic.

112. Section 6quat(5) allows for the reassessment of the rebate in certain circumstances.

TAX REBATE

Qualifying amounts

Section 6quat(1) provides that the rebate is deductible from the normal tax payable by a ‘resident’

in whose taxable income any of the following amounts have been included.

113. Income received by or accrued to the resident from a source outside the Republic which

is not deemed to be from a source within the Republic (other than those dealt with below).

Under the world-wide basis of taxation income derived by a resident from sources in and

outside the Republic will constitute gross income. All income from sources outside the

Republic therefore qualify for the rebate

114. Income referred to in section 9(1)(cA) – income from certain mining operations.

115. Income referred to in section 9(1)(e) – governmental and semi-governmental services

abroad.

116. Income referred to in section 9(1)(fA) – services rendered to miners and prospectors

upon, beneath or above the continental shelf.

117. The proportional amount of a (CFE) that is deemed to be the income of a resident

(section 9D).

Integritax Special Issue – March 2001 – Residence Basis of Tax page 32

118. Foreign dividends (section 9E).

This provision applies subject to the provisions of section 6quat(2), which deals with double

taxation agreements (see below).

Credit amount

Section 6quat(1A) provides that the rebate will be an amount equal to the sum of any taxes on

income proved to be payable without any right of recovery (other than a right of recovery in terms

of an entitlement to carry back losses arising during any year of assessment to any prior year of

assessment) to the government of a country other than the Republic.

The persons who must have paid the tax are

119. a resident,

120. a CFE (in respect of the proportional amount deemed to be the income above),

121. a company (in respect of profits included in the amount of a foreign dividend), and

122. a company (in respect of the proportional amount of any profits from which a dividend is

declared to a CFE, which dividend relates to a proportional amount included in the resident’s

income).

The taxes are those paid to the government of any country other than the Republic in respect of

the amount of any ‘qualifying’ income included in the resident’s taxable income. All foreign

taxes paid on ‘qualifying’ income are taken into account. If more than one foreign tax has been

paid the total taxes are taken into account. This is known as the onshore mixing of foreign tax

credits.

If a partnership or trust is liable for tax as a separate entity in another country, a proportional

amount of any tax payable by this entity that is attributable to the resident in the partnership or the

trust is deemed to be paid by the resident.

Limitation

Section 6quat(1B) provides that the rebate of tax proved to be payable to the government of

another country may not exceed an amount that bears to the total normal tax payable the same

ratio as the total taxable income attributable to the income derived from the other country bears to

the total taxable income.

If more than one foreign tax has been paid the taxable income from all countries must be totalled,

as must the normal tax payable on the aggregated taxable income. (This is part of the system of

the onshore mixing of foreign tax credits.)

Attributable Republic tax

On 26 June 1989 the Commissioner issued his Practice Note 9 entitled ‘Income Tax:

Determination of Tax Attributable to the Inclusion of Certain Amounts in Taxable Income’. It

provides the method to be used when a portion of Republic tax must be determined for purposes

of the limit of the section 6quat rebate. An edited version of this practice note follows:

‘Section 6quat of the Income Tax Act provides for the granting of a rebate against normal tax

in respect of certain other taxes paid by the taxpayer on amounts included in his taxable

income. Section 6quat, however, provides that the rebate is to be limited to the amount of

normal tax which is attributable to the inclusion of the relevant amounts. Many of the double

taxation agreements concluded between the Republic and other states similarly provide for the

granting of relief in respect of foreign taxes paid, subject also to the relief being limited to the

amount of normal tax attributable to the inclusion of the income subject to the foreign tax.

‘The amount of normal tax attributable to the inclusion of a particular amount in income may

be calculated either according to the ‘top slice’ method, in which the amount to be determined

Integritax Special Issue – March 2001 – Residence Basis of Tax page 33

represents the difference between the normal tax calculated on the total taxable income and the

normal tax calculated on the taxable income before the inclusion of the relevant amount, or

according to the pro rata method, in which the amount of attributable tax is determined by

apportioning the total normal tax payable in the ratio which the relevant amount of income

bears to the total taxable income. Inland Revenue has, in certain instances, used the ‘top slice’

method of calculation in the past.

‘In the case of CIR v Estate Late Bulman 1987 (1) SA 659 (A), 49 SATC 1, the Appellate

Division, in considering a similar calculation required to be made for purposes of the proviso to

the First Schedule to the Estate Duty Act, held that the pro rata method was to be used. It is

considered that the reasoning adopted by the Court in that case is applicable also to the income

tax calculation mentioned above, and this calculation will accordingly in future be made on the

pro rata basis.’

Carried forward

When the sum of the taxes payable to the government of any foreign country exceeds the limit as

calculated above, the excess is referred to as the ‘excess amount’. This ‘excess amount’ may not

be refunded to the resident, but may be carried forward to the next year of assessment.

In the next year of assessment an ‘excess amount’ will be deemed to be a tax on income paid to

the government of a foreign country in that year, and it may be set off against the amount of

normal tax payable by the resident in the next year of assessment on any amount from any

country other than the Republic that is included in the resident’s taxable income during the next

of assessment.

In the next year of assessment the excess amount is deducted from the normal tax payable by the

resident only after the deduction of the current rebate attributable to the foreign taxable in the

next of assessment.

An excess amount may not be carried forward for more than seven years calculated from the year

of assessment when it was for the first time carried forward.

‘Foreign’ dividends from a CFE

Provision is made for the situation where tax is payable to the government of a foreign country on

an amount declared to a resident as an ‘exempt’ foreign dividend from a CFE.

If this tax has not been taken into account as a rebate against the normal tax payable by the

resident on the proportionate amount of the CFE’s net income previously included in his taxable

income in terms of section 9D, it may be deducted from the normal tax payable by him during

any year of assessment in which a ‘foreign’ dividend declared to him by the CFE from profits

relating to the proportionate amount previously included in his taxable income.

This means that if a proportional amount from a CFE was taxed in the hands of a resident, but no

rebate was taken into account in respect of that amount, and an exempt foreign dividend is

subsequently declared to him by the CFE out of that amount, a rebate may be deducted by him in

the year in which this exempt ‘foreign’ dividend from the CFE is declared.

Disqualifications

In terms of section 6quat(1B)(d) the taxes payable by the following persons do not qualify for the

rebate.

123. A company distributing a dividend to a resident who holds less than 10% of the equity

share capital in the company for his own benefit.

124. A company that together with any other companies in the same group of companies does

not hold a ‘qualifying interest’ (holds less than 10% of the equity share capital) in the

company for its own benefit.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 34

(See below for the definitions of these terms.)

Net ‘foreign’ dividends

In terms of section 6quat(1B)(e) a resident may not claim the rebate in respect of the tax payable

on a ‘foreign’ dividend if he has made an election to be taxed on his net ‘foreign’ dividends. The

amount he is taxed on when he makes this election is the ‘foreign’ dividend net of any foreign tax

on income or foreign withholding tax on the dividend. Because he has effectively been allowed

the foreign tax as a deduction he does not qualify for any credit relief thereon.

Double taxation agreements

Section 6quat(2) provides that the rebate will not be granted in addition to any relief to which the

resident is entitled under a double taxation agreement with the country concerned. It may,

however, be granted in substitution for the relief to which the resident would be entitled under an

agreement. No indication is given as to who decides which form of relief will be given, but

presumably it is the taxpayer who may elect which concession he would prefer.

Definitions

The term ‘group of companies’ is defined in section 6quat(3) as

‘a group of companies as defined in section 9E’.

A ‘group of companies’ is defined in section 9E as

‘a controlling company and one or more other companies which are controlled companies in

relation to the controlling company’.

The definitions of ‘controlled company’ and ‘controlling company’ are as they appear in

section 9E.

The term ‘qualifying interest’ is defined in section 6quat(3) as

‘a qualifying interest as defined in section 9E’.

In section 9E a ‘qualifying interest’ of a person is defined as

125. a direct interest of at least 10% held by the person in the equity share capital of a

company; and

126. a direct interest of at least 10% held by that company in the equity share capital of any

other company, which other company shall for the purposes of this definition be deemed to be

a company in which any person holds a direct interest of at least 10%.

Conversion of foreign tax

Section 6quat(4) provides that the amount of foreign tax proved to be paid to a foreign country on

an amount included in a resident’s taxable income during any year of assessment must be

converted to the currency of the Republic by applying the ruling exchange rate on the day on

which the foreign tax is actually paid.

If it has not been paid by the last day of the year of assessment, the rate to be used is the ruling

exchange rate on the last day of the year of assessment.

In the situation of ‘foreign’ dividends, section 9E(10) provides for the conversion of the amount

of a ‘foreign’ dividend at the ruling exchange rate applicable on the date of accrual of the

dividend to the resident. It does not specifically provide for the foreign tax to be converted on this

date. But because the amount to be included in the resident’s gross income is a pre-tax amount

(unless he made the election to be taxed on the ‘net’ amount) by converting this amount at the

date of accrual, the tax already paid is also converted on the date of accrual.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 35

Revised assessments

Section 6quat(5) provides for the situation where a rebate against the normal tax payable by a

resident was given in a previous year of assessment which subsequently proves to be incorrect.

An adjustment may then be made

127. if it is proved by the resident that the amount of the tax actually payable to the foreign

government exceeds the amount that was allowed as a rebate, or

128. if the Commissioner is satisfied that the amount of tax actually payable to the foreign

government is less than the amount allowed as a rebate.

The Commissioner will then issue a revised assessment, which will be either a reduced or an

additional assessment, whichever is appropriate, reflecting the amount of the rebate to be allowed.

But the Commissioner may not issue a assessment more than six years from the date of the

original assessment in terms of which the rebate was allowed. If, however, the amount of foreign

tax proved to be payable was incorrectly reflected, was due to fraud or misrepresentation or nondisclosure

of material facts then no time limit applies.

Third provisional taxpayers

The term ‘credit amount’ is defined in section 89quat(1). It is used when determining the amount

that a third provisional taxpayer must pay to ensure that he does not become liable for the

payment of interest. Its provisions have been extended to include in a taxpayer’s credit amount

any amount of foreign tax that may be deducted from the tax payable by him in respect of the

year of assessment in terms of the provisions of section 6quat. A taxpayer’s credit amount is now

the sum of

129. any section 6quat rebate;

130. the first and second provisional taxes paid by him under the provisions of the Fourth

Schedule to the Act;

131. any third (or further) provisional tax paid by him in respect of that year under the

provisions of the Fourth Schedule; and

132. any employees’ tax deducted or withheld by his employer during the year.

PAYE and provisional tax tables

Paragraph 9(1) of the Fourth Schedule has been amended to require the Commissioner when he

prepares the PAYE deduction tables to take into account the rebate provided by section 6quat. And

paragraph 17(5) of the Fourth Schedule has been amended to require the Commissioner when he

prepares the provisional tax tables to take into account the rebate provided by section 6quat

Integritax Special Issue – March 2001 – Residence Basis of Tax page 36

Foreign Dividends and STC

GROSS INCOME

Paragraph (k) of the definition of ‘gross income’ brings into gross income

‘any amount received or accrued by way of dividends including any amount determined in

accordance with the provisions of section 9E in respect of any foreign dividend received by or

accrued to any person who is a resident’.

This provision came into operation on 23 February 2000 and applies in respect of any foreign

dividend

133. received by or accrued to any person on or after 23 February 2000, or

134. which accrued to the person before 23 February 2000 but which is received on or after

23 February 2000.

The provisions of this paragraph do not, however, apply to any dividend declared by a

135. listed company before 23 February 2000, and

136. any unlisted company before 23 February 2000 if its chief executive officer and its

external auditor (or an equivalent person) have declared under oath or affirmation that the

dividend was actually declared by the company before 23 February 2000.

EXEMPTION

Section 10(1)(k) provides that certain dividends received by or accrued to a taxpayer are exempt

from normal tax. This exemption does not, however, extend to every dividend received or

accrued. One of the ‘taxable’ dividends is a foreign dividend. Paragraph (aa) to (dd) inclusive

give the circumstances in which the dividend exemption is not available. Paragraph (dd) applies

to foreign dividends and its effect is as follows:

The dividend exemption shall not apply

‘to the amount of any foreign dividend contemplated in section 9E received by or accrued to

any resident’.

SECTION 9E

To give effect to the taxation of foreign dividends, section 9E was introduced into the Income Tax

Act. Consequential amendments were made to the

137. definitions in section 1 of the Act,

138. credit provisions in section 6quat,

139. controlled foreign entity (CFE) provisions in section 9D, and

140. provisions regulating secondary tax on companies (STC) (sections 64B and 64C).

Section 9E regulates the taxation of foreign dividends. It splits into the following provisions.

141. Section 9E(1) is the definition provision containing the definitions of nine terms.

142. Section 9E(2) deemed a foreign dividend (as defined) to be received by or accrued to a

resident (as defined) from a source within the Republic. This provision has now been repealed

because its provisions are already covered by the amended definition of ‘gross income’ which

include the world-wide receipts and accruals of a resident in his gross income.

143. Section 9E(3) gives the amount to be included in gross income which varies under two

different circumstances. One of these circumstances includes a ‘proportionate amount of the

profit’ (a defined term) to be included in gross income.

144. Section 9E(4) then gives the determination of a ‘proportionate amount of the profit’.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 37

145. Section 9E(5) deems a dividend received by an equity unit trust that is ‘on-distributed’ to

be received by its unit-holders.

146. Section 9E(5A) allows certain deductions for expenses incurred in producing a foreign

dividend.

147. Section 9E(6) allows a resident to elect to include in his gross income the after-tax

amount of the dividend.

148. Section 9E(7) provides for five situations when a foreign dividend will not be taxed in the

Republic (exemptions).

149. Section 9E(8) allows the Minister of Finance to designate certain countries from where

dividends accruing could qualify for exemption.

150. Section 9E(8A) allows the Minister of Finance to exempt certain foreign dividends.

151. Section 9E(8B) allows the Minister of Finance to withdraw any exemption given under

section 9E(8A).

152. Section 9E(9) provides that any discretion exercised by the Commissioner is subject to

objection and appeal.

153. Section 9E(10) provides the method to be used to convert a foreign dividend into the

currency of the Republic.

DEFINITIONS

Section 9E(1) contains nine definitions, namely, the definitions of

 a ‘controlled

company’,

 a ‘controlling company’,  a ‘designated

country’,

 an ‘effective date’,  ‘fixed capital’,  a ‘foreign dividend’,

 a ‘group of

companies’,

 a ‘proportionate amount of the profit’,

and

 a ‘qualifying

interest’.

Foreign dividend

A ‘foreign dividend’ is defined as a dividend received by or accrued to a person from any

company that is either

154. a foreign entity as defined in section 9D, or

155. a resident to the extent that the dividend is declared from profits derived by it before it

became a resident.

The definition of a ‘foreign dividend’ also makes provision that certain amounts are deemed to be

foreign dividends. These include

156. certain amounts which are deemed to be dividends declared by any company as

contemplated in section 64C (deemed dividends); or

157. amounts derived by the shareholder from the disposal of any share in a company if these

amounts represent undistributed profits in the company which were available for distribution

to the shareholder.

A dividend from a foreign entity is a foreign dividend as defined. And a dividend declared by a

resident company from profits derived by it before it became a resident is also a foreign dividend

as defined.

Because resident companies are taxable on their foreign income, the definition of a ‘foreign

Integritax Special Issue – March 2001 – Residence Basis of Tax page 38

dividend’ only includes dividends declared by non-resident companies. Dividends declared from

profits which were already taxed in the Republic will be exempt. A dividend distributed by a

resident company from profits derived by it before it became a resident is, however, a foreign

dividend as defined.

Qualifying interest

The definition of a ‘qualifying interest’ of any person is as follows: It means

158. any direct interest of at least 10% held by any person in the equity share capital of any

company, and

159. any direct interest of at least 10% held by any company in the equity share capital of any

other company, which other company shall for the purposes of this definition be deemed to be

a company in which any person holds a direct interest of at least 10%.

Example

The following example illustrates the holding of a ‘qualifying interest’ in a company.

A South African resident holds 70% of the shares in C, a Chilean company. C in turn holds 10%

in P, a Peruvian company. Although the effective interest of the resident in company P is 7%

(70% of 10%), a ‘qualifying interest’ in P exists. The reason is that

160. the direct interest of the resident in C, and

161. the direct interest of C in P

are both at least 10%.

Other definitions

The other definitions are self-explanatory.

AMOUNT

Section 9E(3) provides for the determination of the amount of the foreign dividend that is to be

included in a resident’s gross income.

It provides that in the situation of residents with shareholdings of 10% or more (a ‘qualifying

interest’), the foreign dividend earned is to be grossed up by the amount of the underlying

corporate taxes paid in respect of the profits from which the dividend was ultimately distributed

plus any withholding tax paid in respect of the dividend.

If no evidence is produced by the resident to show the contrary, the dividend is deemed to be

distributed out of the most recently derived profits, in other words on a last-in-first-out (LIFO)

basis. And when a company has derived its profits by way of dividends and non-dividends, any

dividend it declares is deemed to have been distributed on a pro rata basis out of its dividends

and non dividends.

In the situation of residents with a shareholding of less than 10% (no ‘qualifying interest’ exists)

the foreign dividend earned is grossed up by only the amount of the withholding tax.

PROPORTIONATE AMOUNT

To determine the proportionate amount of the profit to be included in the resident’s gross income

the dividends received from another company (the second company) by the distributing company

(the first company) must be taken into account. This provision applies only if the resident holds a

‘qualifying interest’ in the second company (section 9E(4)).

Section 9E(4)(a) provides that unless the resident proves otherwise, a dividend is deemed to be

distributed by the second company out of its profits most recently derived and available for

distribution, in other words on the LIFO basis

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Section 9E(4)(b) provides that when the second company has derived its profits by way of

dividends and non-dividends, any dividend it declares is deemed to have been distributed on a pro

rata basis out of its dividends and non-dividends.

EQUITY UNIT TRUSTS

In the situation of an equity unit trust (which is a company for income tax purposes), income in

the form of foreign dividends is treated on the same basis as interest. In this regard

section 10(1)(iA) has been amended to provide that foreign dividends are exempt from tax in the

hands of the equity unit trust if they had been ‘on-distributed’ to the unit-holders.

Section 9E(5) regulates the situation where an equity unit trust ‘on-distributes’ to its unit-holders

foreign dividends received by it or which accrued to it. Where a distribution of this nature takes

place the foreign dividend is deemed to have been declared directly to the unit-holder. This

enables the unit-holder

162. to be taxed on the foreign dividend at the tax rates applicable to him (the unit-holder),

163. to claim any withholding tax imposed in respect of the foreign dividend as a credit

against his South African tax liability, and

164. in the situation of an individual to use the applicable exemptions in respect of foreign

dividends and interest.

DEDUCTIONS

The general deduction formula allows expenditure and losses to be deducted in the determination

of the taxable income derived from the carrying on of a trade. A taxpayer is therefore not allowed

to deduct expenditure incurred in earning a foreign dividend, because it is not derived from the

carrying on of a trade.

Section 9E(5A), however, overrules this ‘trade’ requirement in limited circumstances. It provides

that certain deductions may be made notwithstanding the provisions of section 11(a) and

section 23(g) (the general deduction formula). What may be deducted is interest actually incurred

by a resident in the production of a foreign dividend. The deduction is limited to the amount of

foreign dividends included in the gross income of the resident during the year. The deduction is

only for interest incurred. It does not extend to other expenditure incurred in earning foreign

dividends, for example, fees or commissions.

The following further conditions apply.

165. First, the amount by which the interest incurred exceeds the foreign dividends derived

during a year of assessment must be reduced by the amount of any ‘exempt’ foreign dividends

earned by the resident during that year of assessment.

166. Secondly, any balance of interest remaining is carried forward to the next year of

assessment where it is deemed to be an amount of interest actually incurred by the resident in

the production of foreign dividends in the next year.

It is possible that interest is incurred in one year in respect of foreign dividends to be earned in a

future year of assessment. It may not be possible at the time the interest is incurred to determine

whether the foreign entity will in fact declare a dividend and, if so, whether or not it will be

exempt in terms of section 9E (see below). As a result the deduction of any interest incurred in

respect of foreign dividends is only deductible to the extent that foreign dividends are included in

gross income. Any excess amount (after reducing it by the amount of exempt dividends earned

during the year) is carried forward to the next year.

ELECTION

To reduce the administrative impact and compliance burden of determining the underlying

corporate taxes and withholding tax imposed on a dividend, provision is made for a resident to

Integritax Special Issue – March 2001 – Residence Basis of Tax page 40

elect that only the net amount of the dividend received is included in his gross income.

Where at least 10% of the equity share capital is held, the gross dividend is reduced by both

foreign taxes on income and any withholding tax paid. Where less than 10% of the equity share

capital is held the gross dividend is reduced by only any withholding tax paid.

This election is contained in section 9E(6) and may be made on an annual basis. If the election is

made it is only valid in respect of all dividends received by or accrued to the resident during the

year of assessment in respect of which the election is made.

Where the election is made no adjustment needs to be made in respect of underlying taxes

imposed on the profits declared as a dividend.

The effect of the election is that a deduction is granted for foreign taxes attributable to the

dividends included in the gross income of the resident during the year of assessment.

These foreign taxes are then prohibited from being taken into account in granting foreign tax

credits (in this regard see section 6quat(IB)(e)).

RELIEF MEASURES

Certain relief measures have been introduced to avoid double taxation. These relief measures fall

into the following two categories:

167. First, an exemption method in terms of which the foreign dividend is exempt from tax

(section 9E(7) and (8A)).

168. Secondly, a credit method in terms of which the foreign dividends are taxed in South

Africa, but credit is allowed in respect of certain foreign taxes paid (section 6quat).

EXEMPTIONS

An accepted international principle is to completely exempt certain foreign dividends. The

rationale therefore is that it is administratively expedient to exclude dividends where the tax

payable on the underlying profits to which the dividend relates is of such a magnitude that a credit

equal to virtually the full amount of the domestic tax will have to be granted.

The following exemptions have been provided for in section 9E(7).

Listed shares (section 9E(7)(c))

To address the administrative implications in respect of a large number of portfolio shareholders

and the potential impact on the local market and the economy, the provisions relating to the

taxation of foreign dividends will not apply to dividends declared by companies listed on the

Johannesburg Stock Exchange (JSE).

This exemption will, however, only apply where dividends are distributed to a resident

shareholder that, together with his connected persons, has an interest of less than 10% in the

equity share capital of the listed company, and if at least 10% of the equity share capital of the

company is held in aggregate by South African residents (section 9E(7)(c)).

A similar exemption applies in respect of the proportionate amount of investment income deemed

to be the income of resident shareholders in a listed company in terms of the CFE provisions of

section 9D. This exemption will apply where the proportionate amount of investment income is

calculated with reference to the income of the listed company or of a subsidiary of the listed

company. This exemption is contained in the new provision, section 9D(9)(g).

If the listed company does not comply with the 10% aggregate shareholding requirement on the

date of declaration of the dividend and the foreign profits were not taxed in South Africa, the

shareholders will be taxed on the foreign dividends and the credit provisions will apply.

Any foreign dividends received by JSE listed companies from their subsidiaries will be subject to

the normal provisions relating to foreign dividends.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 41

To remove the possibility of foreign companies operating in low-tax-rate countries listing on the

JSE after the effective date in order to exploit the above exemption, a system will be introduced

whereby these foreign listed companies will have to be approved before residents will qualify for

the exemption.

Designated countries (section 9E(7)(d))

When a shareholder has a shareholding of at least 10% (a ‘qualifying interest’) in a foreign

company in a designated country certain foreign dividends declared from profits that are taxed on

a similar basis to that of the Republic, and at a rate of at least 27% are exempt (section 9E(7)(d)).

Certain countries with a basis and rate of tax similar to the Republic, will be designated by the

Minister of Finance by way of a notice in the Gazette. The powers to designate these countries are

contained in section 9E(8). A list of designated countries was published in GN 866 Government

Gazette 21526 of 1 September 2000.

Included in this list were the following countries.

 Algeria,  Australia,  Austria,

 Belgium,  Canada,  Croatia,

 Czech Republic,  Denmark,  Egypt,

 Finland,  France,  Germany,

 Israel,  Italy,  Japan,

 Republic of Korea,  Lesotho,  Malawi,

 Namibia,  Netherlands,  Norway,

 Poland,  Romania,  Slovak Republic,

 Swaziland,  Sweden,  Thailand,

 Tunisia,  United Kingdom,  United States of America,

 Zambia, and  Zimbabwe.

Any foreign dividends received from profits generated in any designated country are exempt to

the extent that the underlying profits were subject to tax at a ‘statutory’ rate of at least 27%. The

legislation refers to a ‘statutory’ rate because an effective tax rate takes into account special losses

and deductions or incentives available in the calculation of the actual tax liability of a company.

The rate must be payable without any right of recovery after taking into account the application of

any double taxation agreement. If the designated country imposes tax on a company at a

progressive scale of statutory rates, the statutory rate is deemed to be the highest rate on the scale.

This exemption will not apply in respect of dividends distributed to shareholders who hold less

than 10% of the equity share capital in a company (see the definition of a ‘qualifying interest’ in

section 9D(1)).

Example

This exemption is illustrated in the example that follows:

A resident owns 10% of the shares in an American company which provides professional

services. The profits of the company available for distribution have been taxed at a rate of 35%. A

Integritax Special Issue – March 2001 – Residence Basis of Tax page 42

dividend of R95 000 is paid by this company to the Republic resident and a withholding tax of

R5 000 is imposed on the resident. As the resident received the dividend from

169. a company in a designated country (the United States of America),

170. the underlying profits were taxed at a rate of at least 27%, and

171. the resident owns 10% of the equity share capital of the company declaring the dividend,

the dividend is exempt (section 9E(7)(d)).

The withholding tax may not then be set off against the resident’s South African tax liability

because the dividend was exempt. To qualify for a section 6quat rebate the amount of foreign

income must be included in the resident’s South African taxable income.

Double taxation (section 9E(7)(e))

In order to avoid double taxation of profits distributed by way of a dividend to a resident, an

exemption exists for the portion of a dividend declared from profits which

172. relate to income that has already been included in the income of a resident shareholder in

terms of the provisions of section 9D (section 9E(7)(e)(i));

173. are subject to tax in the Republic in terms of the Income Tax Act (section 9E(7)(e)(ii)); or

174. have been taxed as deemed foreign dividends when a loan was granted to a recipient

(section 9E(7)(e)(iii)).

Funded by ‘local’ dividends (section 9E(7)(e)(iv))

Section 9(7)(e)(iv) applies to dividends distributed out of profits that arose directly or indirectly

from dividends declared by a company that is a resident. This means that if a resident company

declares a dividend to a company that is a foreign entity and this foreign entity then distributes a

dividend out of these ‘local’ dividends it received to a resident, this dividend will be exempt from

tax.

Funded by ‘exempt’ foreign dividends (section 9E(7)(f))

Section 9E(7)(f) exempts dividends declared out of profits derived by a company by way of

exempt foreign dividends. This means that if a dividend is funded by ‘exempt’ foreign dividends

it will be exempt from tax.

Approved projects (section 9E(8A))

Section 9E(8A) provides that the Minister of Finance may, by notice in the Gazette, to the extent

that he may deem it necessary in the national interest and subject to certain conditions, grant

exemption from the application of section 9E in respect of certain foreign dividends that are

remitted to the Republic. This concession is sometimes referred to as ‘tax sparing’.

The ‘qualifying’ dividends are those

175. received by or accrued to a resident;

176. that are remitted to the Republic;

177. to the extent that they are declared from profits derived from a project approved by the

Minister.

In approving the project, the Minister must have regard to

178. the economic benefits of the project for the Republic;

179. the extent to which goods and services will be provided for the project from the Republic;

180. the potential effect the project may have on the South African tax base;

Integritax Special Issue – March 2001 – Residence Basis of Tax page 43

181. other assistance granted by the Government or a semi-Government body for the project;

and

182. any other criteria that the Minister may prescribe by notice in the Gazette.

This exemption may be withdrawn by the Minister if he is satisfied that any condition imposed

has not been complied with (section 9E(8B)).

No credit

Where a dividend is exempt in full or in part, the foreign taxes on income in respect of the profits

from which the exempt dividend is distributed, as well as foreign withholding taxes in relation to

the dividend, are not allowed as a credit against the South African tax liability. The reason why

the foreign taxes do not qualify for credit is because the exempt dividend is not subject to tax in

South Africa (section 6quat).

DESIGNATED COUNTRIES

The Minister of Finance is empowered to designate countries as ‘designated countries’ by notice

in the Gazette. In terms of s 9E(8), the Minister may designate countries

183. which have a tax on income that is determined on a basis that is substantially the same as

that of the Republic;

184. have a statutory rate of tax on income of companies of at least 27% without any right of

recovery of the tax by any person (other than a right of recovery in terms of an entitlement to

carry back losses arising during a year of assessment to a prior year of assessment); and

185. comply with any other requirement that the Minister may prescribe by regulation.

OBJECTION AND APPEAL

Section 9E(9) provides that any discretion exercised by the Commissioner under the provisions of

section 9E is subject to objection and appeal.

CONVERSION RATE

Section 9E(10) provides that the amount of a foreign dividend to be included in the gross income

of a resident must be converted into the currency of the Republic at the ruling exchange rate

applicable on the date on which the dividend accrued to the resident.

DISCLOSURE

Section 70(2) requires a company to furnish the Commissioner with an annual return giving

details of dividends distributed. Section 70(2)(b) requires a company that is a resident to notify

each shareholder who is a resident of the amount of any ‘taxable’ foreign dividend.

THE SECTION 6QUAT REBATE

The rules governing the credit method are contained in section 6quat and in section 9E(3) and (4)

(see Lecture 4 in this regard).

Where resident shareholders hold at least 10% of the equity share capital (a ‘qualifying interest’)

of the company declaring a foreign dividend, but the underlying profits were not taxed at a

comparable rate and basis to that of South Africa (at a rate of at least 27%) in a designated

country, no exemption will apply (see above). In this instance the dividend will be taxed and the

foreign tax payable on the underlying profits from which the dividend was distributed will be

allowed as a credit against the South African income tax payable.

The amount to be taxed in the hands of the resident is not the net dividend received or accrued,

but the ‘grossed-up’ amount. This ‘grossed-up’ amount is the equivalent of the pre-tax profit out

of which the dividend was declared. A credit is then granted for both the corporate tax paid in

respect of that profit and any withholding taxes levied on the dividend.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 44

The tax to be taken into account is not limited to the foreign tax paid by the company declaring

the dividend, but a ‘look-through’ approach is adopted to determine the tax on the underlying

profits. For this purpose a ‘qualifying interest’ is defined as the indirect interest held by a resident

shareholder through a chain of companies where each company in the chain of companies holds a

direct interest of at least 10% in the company in the next tier.

Where the income from which the dividend is distributed is derived from more than one source of

profits, the dividend will be deemed to be distributed on a pro rata basis from the profits derived

by the company from the different sources.

Income in the context of ‘taxes on income’ includes profits, income and gains. Taxes on income

imposed by national and certain lower tiers of government in a foreign country qualify. And

capital gains taxes also qualifies as a rebate against the South African tax liability.

SHAREHOLDERS WITH A LESS THAN 10% SHAREHOLDING

Shareholders who have less than a 10% shareholding will be taxed on their foreign dividends.

They will be allowed a credit only in respect of the withholding tax paid offshore. But where the

shares are held in a company listed on the JSE, which satisfies the 10% in aggregate shareholding

requirement, the dividend declared out of foreign-source income will be exempt

(section 9E(7)(c)).

The amount to be taxed in the hands of a resident with a shareholding of less than 10% will be the

aggregate of the foreign dividend received and the withholding tax borne by the resident in

respect of the foreign dividend.

The withholding tax paid will be allowed as a credit against the South African tax liability in

respect of the foreign dividend.

Example

The following example illustrates the position.

A South African resident owns 9% of the shares in a company conducting business in Germany.

The company distributes all its profits in the form of dividends. It has a R10 million taxable

income and declares a dividend of R7 million after having paid R3 million in taxes. The resident

receives a dividend of R535 500 after the deduction of a withholding tax of R94 500. The

dividend before the deduction of the withholding tax was R630 000 (9% of the R7 million

dividend).

As the resident owns less than 10% of the shares in the foreign company, the foreign dividend

accruing to the resident will not qualify for an exemption. The amount on which the resident will

be taxed is the gross dividend of R630 000 (R535 500 plus R94 500). The resident will be able to

claim the withholding tax of R94 500 against his South African tax liability on the foreign

dividend.

DEEMED DIVIDENDS AND DEEMED FOREIGN DIVIDENDS

Section 64C of the Income Tax Act operates as an anti-avoidance measure in certain

circumstances where a company may attempt to avoid STC. This is the situation where a company

would, for example, instead of declaring a dividend and paying STC thereon, lend its profits to a

shareholder. Section 64C effectively neutralises an initiative of this nature by deeming certain

loans without a market-related rate of interest to be a dividend.

Loans

The principles contained in section 64C relating to deemed dividends have been amended so that

they also apply for purposes of the taxation of foreign dividends (see the definition of a ‘foreign

dividend’ in section 9E(1) paragraph (a)). Amounts distributed by a foreign company which is a

controlled foreign entity in the form of, for example, a loan, which would have been regarded as a

dividend declared for purposes of STC, had the distribution been made from local-source profits,

Integritax Special Issue – March 2001 – Residence Basis of Tax page 45

will, therefore, also be regarded as a foreign dividend.

The profits from which the company could have distributed the dividend must be profits which

were not subject to tax in the Republic.

The provisions will, however, not apply where a company is being wound up or liquidated or

whose corporate existence is finally terminated, and an amount is distributed by it out of profits of

a capital nature (other than profits of a capital nature derived from the disposal by it on or after

23 February 2000 of any interest in any other company with retained profits which were available

for distribution by this other company) (see the definition of a ‘foreign dividend’ in section 9E(1)

the proviso to paragraph (a)).

Sale of shares

A further method of avoiding the tax on foreign dividends is to sell the shares of the company

instead of declaring a dividend. The accumulated profits in the company are, therefore, recovered

in the form of ‘capital’ proceeds. No foreign dividend would arise and no tax would be paid.

In this regard, a provision has been inserted in the Act (see the definition of a ‘foreign dividend’

in section 9E(1) paragraph (b)) to provide that where a disposal of shares takes place, the

shareholder will be deemed to have received a dividend to the extent that the proceeds on the sale

represents undistributed profits that could have been distributed to the shareholder, in proportion

to his shareholding, and which would have been taxable as a foreign dividend.

The amount of the deemed foreign dividend from the disposal of a share or interest in the fixed

capital in a company is limited to the extent that the company or any of its subsidiaries has

undistributed profits that were not subject to tax in the Republic, which were directly or indirectly

available for distribution to him. The company will be regarded as having qualifying

undistributed profits if it has amounts that are deemed to be available for distribution in terms of

the definition of a ‘dividend’ in section 1, that is, when it has capitalised distributable profits in

the past, for example, capitalised revenue and capital reserves.

This deeming provision arising on the disposal of shares will not apply to disposals of shares,

186. by a South African resident who at no time on and after 23 February 2000 held 10% or

more of the equity share capital of the company;

187. to a South African resident, where he after he has purchased the shares, holds at least

10% of the equity share capital of the company;

188. where a South African resident retains the same effective shareholding in the company

whose shares are sold after the disposal, as to what he had prior to the disposal, except where

one of the main purposes of the disposal is the avoidance, postponement or reduction of

liability for the payment of any tax, duty or levy. This provision also applies when the seller is

a controlled foreign entity in relation to any resident and that resident retains the same

effective interest in the equity share capital or fixed capital of the company as prior to the

disposal. The ‘fixed capital’ of a company is defined as including ‘share capital, share

premium and accumulated profits, whether of a capital nature or not’;

189. by a shareholder who acquired the shares from a non-resident unconnected person, to the

extent that the undistributed profits were derived prior to the acquisition of the shares by the

shareholder;

190. to the extent that the proceeds from the disposal have been included in the income of the

person disposing of the shares (for example, a dealer); or

191. where the Commissioner is satisfied that the disposal of the shares or the non-declaration

of dividends by the company whose shares are sold was not effected as part of a scheme for

purposes of avoiding the liability for any tax, duty or levy, taking into account any conditions

that the Minister may prescribe by way of regulation.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 46

Example

A South African company has a wholly-owned subsidiary in a tax haven, where profits on

international trading activities have been accumulated over a number of years. The subsidiary has

undistributed profits the equivalent of R50 million which were subject to tax the equivalent of

R2,5 million in the tax haven. The assets of the subsidiary are a loan to another company in its

group and investments administered by a New York fund manager. All the shares are sold by the

South African company to an offshore financial institution for an amount of R45 million. The

South African company will be subject to tax on a deemed foreign dividend of R45 million. A

credit for foreign tax paid of R2,25 million (R45 million/R50 million x R2,5 million) will be

available for set-off against the South African tax liability.

STC

Amendments have been made to section 64B which deals with the secondary tax on companies

(STC) and to section 64C which deems certain amounts to be a dividend for STC purposes.

Liability for STC

STC is now payable only by a company that is a ‘resident’.

‘Qualifying’ dividends accrued

STC is calculated on the ‘net amount’ of a dividend declared by a company. The ‘net amount’ of a

dividend is the amount by which the dividend declared by a company exceeds the sum of any

‘qualifying’ dividends accruing to the company during the dividend cycle in relation to that

dividend. Certain dividends accruing to the company are, however, not deductible. Most foreign

dividends are not deductible, but some ‘exempt’ foreign dividends are ‘qualifying’ deductible

dividends. Added to these deductible foreign dividends are those that are exempt from tax in

terms of section 9E(7)(e)(iii) or (iv) or (f) or section 9E(8A). The deductible foreign dividends are

as follows:

192. Section 9E(7)(c) – foreign dividends from companies listed on the Johannesburg Stock

Exchange.

193. Section 9E(7)(d) – foreign dividends from ‘qualifying’ designated countries.

194. Section 9E(7)(e)(ii) – foreign dividends distributed out of that have already been taxed in

the Republic.

195. Section 9E(7)(e)(iii) – foreign dividends distributed by a company to the extent that the

profits from which it is distributed have been included in the shareholder’s taxable income in

terms of paragraph (a) of the definition of a ‘foreign dividend’, that is, as a deemed foreign

dividend when a loan was granted to a recipient.

196. Section 9(7)(e)(iv) – foreign dividends distributed out of profits that arose from dividends

declared by a resident company.

197. Section 9E(7)(f) – foreign dividends declared out of profits derived by a company by way

of exempt foreign dividends. These dividends may also not be deducted in the determination

of the shareholder company’s net income subject to STC.

198. Section 9E(8A) dividends referred to in section 9E(8A) are those emanating from profits

from certain projects that have been approved by the Minister of Finance.

The only ‘exempt’ foreign dividend that does not qualifying as a deductible dividends accrued for

STC purposes is as follows:

199. Section 9E(7)(e)(i) – foreign dividends from a controlled foreign entity whose ‘net

income’ has already been included in Republic gross income in terms of section 9D.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 47

Exemptions from STC

Section 64B(5)(h) exempted from STC dividends declared out of profits by a company that has its

place of effective management outside the Republic that carries on a trade through a branch or an

agency within the Republic. Now that STC is payable only by a company that is a ‘resident’ this

exemption has been deleted.

Ratio

Section 64B(6) provides that when a company derives local and foreign profits, its liability for

STC is determined with reference to the local portion of its profits. Local profits for this purpose

are, those derived from sources within or deemed to be within the Republic in terms of section 9.

Added to the profits regarded as local for the purposes of this ratio determination are those

derived from sources outside the Republic that are not deemed to be from a source in the

Republic. These profits must not be exempt from tax in terms of section 10(1)(kA) which

provides that profits from certain designated countries are exempt. Foreign profits that are taxable

in the Republic under the world-wide basis of taxation are therefore regarded as local profits for

the purposes of the ratio determination.

Deemed dividend exclusions

Section 64C(4)(d) provided that a ‘qualifying’ loan would not be a deemed dividend if it was

200. denominated in the currency of the Republic and was subject to a rate of interest not less

than the ‘official rate of interest’, or

201. denominated in a foreign currency and was subject to a market-related rate of interest.

This provision has been amended to remove the distinction between loans denominated in the

currency of the Republic and other loans. All loans will not be deemed dividends if interest is

levied at the ‘official rate of interest’. And then the definition of the ‘official rate of interest’ has

been amended to provide that it is the rate of interest fixed by the Minster from time to time by

notice in the Gazette in respect of loans denominated in the currency of the Republic and a

market-related rate of interest for other loans. The effect of these amendments is therefore solely

of a structural nature.

Section 64C(4)(j) has been enacted to provide for a further situation in which a loan is not

deemed to be a dividend. It applies to any loan granted to a recipient company by any other

company that holds for its own benefit, directly or indirectly, any of the equity share capital of the

recipient company. But this concession will not apply when the recipient company (the borrower)

holds any of the equity share capital of the other company (the lender).

Integritax Special Issue – March 2001 – Residence Basis of Tax page 48

Section 7 and Trusts

DEEMED INCOME

Three new provisions have been inserted into section 7 of the Act, namely, section 7(8), (9) and

(10).

Section 7(8) applies when by reason of or in consequence of a donation, settlement or other

disposition made by a resident, income is received by or accrued to a person who is not a resident.

The resident must include in his income so much of the amount of income caused by the

donation, settlement or other disposition.

When the income consists of foreign dividends, the income to be included must be determined in

accordance with the provisions of section 9E as if the ‘donee’ was a shareholder who is a

resident.

The provisions of section 7(8) do not apply to

202. a donation, settlement or other disposition made to a foreign entity of a public character,

and

203. if the non-resident ‘donee’ is a controlled foreign entity.

(The provisions of section 7(8) were previously contained in section 9D(4).)

Section 7(8) (like most other provisions in section 7) employs the term ‘any donation, settlement

or other [similar] disposition’. This term is not defined in the Act but the court has laid down the

following principles:

204. The words ‘any donation, settlement or other disposition’ in section 7 excludes any

disposal of property made for due consideration.

205. The word ‘disposition’ means any disposal of property made wholly or to an appreciable

extent gratuitously out of the liberality or generosity of the disposer.

206. Where there is a settlement or other disposition for some consideration but there is also

an appreciable element of gratuitousness, the resulting income may be apportioned between

these two elements. If no apportionment is possible or if the parent fails to produce evidence

to justify an apportionment, the whole of the income must be regarded as having been derived

by the child by reason of a gratuitous disposition. Ovenstone v SIR 1980 (2) SA 721 (A), 42

SATC 55.

In addition the court has held that the word disposition in section 7 was ejusdem generis with the

word ‘donation’ and ‘settlement’ in this provision and did not include a transaction made for full

value. Joss v SIR 1980 (1) SA 674 (T), 41 SATC 206.

It follows that if there is a sale made at full value then no disposition has taken place. But if the

purchase consideration is not settled and is not charged with interest then in effect a ‘continuing

donation’ is taking place and it is within the meaning of a ‘disposition’.

If part of the purchase consideration has been settled and the balance is still outstanding, then

section 7(8) can apply to portion of the resulting income.

Section 7(9), provides that when an asset has been disposed of for a consideration that is less than

its market value, the amount by which the market value exceeds the consideration will for the

purposes of section 7 be deemed to be a donation. (These provisions were previously contained

in section 9D(5).)

Section 7(10) provides that a resident who at any time during a year of assessment makes a

donation, settlement or other disposition must disclose this fact to the Commissioner in writing

when submitting his return of income for that year. He must also provide any other information

required by the Commissioner for the purposes of section 7. (These provisions were previously

Integritax Special Issue – March 2001 – Residence Basis of Tax page 49

contained in section 9D(7).)

TRUSTS

The legislature reacted to the decision in the case of Friedman & others NNO v CIR: in re Phillip

Frame Will Trust v CIR 1991 (2) SA 340 (W), 53 SATC 166 (This judgment was confirmed on

appeal by the Appellate Division of the Supreme Court in Friedman & others NNO v CIR 1993

(1) SA 353 (A), 55 SATC 39) by amending the definition of a ‘person’ in section 1, and by

creating a new provision, section 25B, which deals with the taxation of the income of trust funds

and the beneficiaries of these funds.

Definition of a trust

In drawing up the legislation applicable to trusts, it would seem that the legislature took into

account the rules from case law that were previously used when the taxation of trusts and their

beneficiaries was levied. Thus the legislation, as amended in 1991, did not result in a trust being

taxed in a different way. All that was different was that the method of taxation was supported by

legislation, rather than by case law.

The definition of a ‘person’ in section 1 was expanded to include a trust and then a trust was

defined as

‘any trust fund consisting of cash or other assets which are administered and controlled by a

person acting in a fiduciary capacity, where such person is appointed under a deed of trust or by

agreement or under the will of a deceased person’.

This definition includes both inter vivos and testamentary trusts.

Section 25B

Section 25B deals with the receipts and accruals, expenses, allowances and distributions of trust

funds. It contains the following eight provisions.

207. Section 25B(1) which identifies who will be taxed on the receipts and accruals of a trust –

the creator, the beneficiary or the trust itself.

208. Section 25B(2) provides that when the trustees exercise their discretion to make an award

to a beneficiary, the beneficiary’s contingent right to this award becomes a vested right.

209. Section 25B(2A) provides that when a resident beneficiary acquires a vested right to an

amount representing capital, this amount is included in his income.

210. Section 25B(3) provides that the allowances and deductions of a trust are available to the

person in whose income the receipts and accruals of the trust were included, subject to a

prohibition in the situation of a discretionary trust.

211. Section 25B(4) limits the amount of the allowances and deductions of a beneficiary to the

income from the trust.

212. Section 25B(5)(a) allows the prohibited allowances and deductions of a beneficiary to be

deducted by a resident trust if it has sufficient income. Section 25B(5)(b) allows the prohibited

allowances and deductions from a non-resident trust to be carried forward by the beneficiary

for possible deduction in the next year of assessment

213. Section 25B(6) allows the non-deducted portion of allowances and deductions to be

carried forward to the next year of assessment.

214. Section 25B(7) makes the limitation and transfer provisions not applicable when the

income of a beneficiary from the trust is not taxable in the Republic.

Controlled foreign entity

It is important to note that the definition of a ‘foreign entity’ in section 9D(1) specifically

Integritax Special Issue – March 2001 – Residence Basis of Tax page 50

excludes a ‘trust’. A result is that an offshore trust is not subject to the provisions of section 9D. It

is, however, subject to the provisions of section 25B(2A) (see below).

RECEIPTS AND ACCRUALS

Section 25B(1) provides that any income received by or accrued to or in favour of any person in

his capacity as the trustee of a trust fund will, to the extent to which it has been derived for the

immediate or future benefit of an ascertained beneficiary with a vested right to the income, be

deemed to be income which has accrued to that beneficiary.

To the extent that any income received by or accrued to or in favour of the trustee has not been

derived for the immediate or future benefit of an ascertained beneficiary with a vested right to the

income – in other words the beneficiaries only have contingent rights to the income – it will be

deemed to be income accruing to the trust fund (section 25B(1)). The trustee will be liable for the

tax on this income in a representative capacity.

Section 25B(1) is made subject to the provisions of section 7, which deems the income derived by

a trustee in consequence of a ‘donation, settlement or other disposition’ to be the income of the

donor. It should be noted that the provisions of section 7 are unlikely to apply to testamentary

trusts as in most situations a ‘donation, settlement or other disposition’ would not have taken

place.

EXERCISE OF A DISCRETION

Section 25B(2) provides that when a beneficiary has acquired a vested right to any income

referred to in section 25B(1) in consequence of the exercise by the trustee of a discretion vested in

him in terms of the trust deed, agreement or will, the income will for the purposes of

section 25B(1) be deemed to have been derived for the benefit of that beneficiary.

OFFSHORE TRUSTS

Section 25B(2A) provides for the situation where any ‘resident’ in relation to a trust acquires a

vested right to an amount representing capital of a trust where

215. this capital arose from income of the trust during previous years of assessment in which

the ‘resident’ only had a contingent right in relation to this income, and

216. this income was not previously subject to tax in the Republic.

Where a ‘resident’ acquires a vested right to an amount representing capital, it will be included in

the income of the ‘resident’ in the year of assessment in which the ‘resident’ acquires the vested

right.

Inter vivos trusts

As it is likely that the income of an inter vivos trust is caused by a donation, settlement or other

disposition (see below) the provisions of section 7(5) may apply to all or a portion of the income

retained in the trust that no beneficiary has a vested right to.

The ‘donor’ will, in terms of section 7(5), be required to include the retained income of the trust

in his gross income if he is a resident. This inclusion in gross income will cause the retained

income of the trust to be subject to tax in the Republic (in the hands of the resident ‘donor’). This

in turn, means that the provisions of section 25B(2A) cannot apply.

It is only when the income of an inter vivos trust is not caused by a donation, settlement or other

disposition that the provisions of section 25B(2A) could apply to its retained income. After the

trust has been in existence for a period of time it is possible that a ‘disposition’ no longer exists

and therefore the provisions of section 7 will not apply. Where the income is caused both by a

‘disposition’ and by a transaction carried out at full value, then it is possible to apportion the

income with only a portion being subject to the provisions of section 7.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 51

Capital beneficiaries

Although a trust is subject to normal tax on an annual basis and prepares annual financial

statements, the ‘annuality’ concept does not necessarily apply to it. For example, a discretionary

trust could provide for its receipts and accruals to be built up, say, for ten years, before the

trustees decide to exercise their discretion and to make an award to a beneficiary. It is therefore

necessary to examine the trust deed to establish whether the annual retained earnings of the trust

vest in any person.

The trust deed may provide that the annual retained earnings vest in the capital beneficiaries and

must be ‘capitalised’ and reinvested for their benefit. On the other hand the trust deed may

provide that the capital beneficiaries do not have a vested right to any annual retained earnings of

the trust.

Section 25B(2A) will apply to an offshore trust in which no beneficiary has a vested right to the

income but where a resident beneficiary has a vested right to the capital and to any retained

annual earnings. It means that if the income of an offshore trust in its previous year of assessment

is not distributed in that year, but a resident beneficiary acquires a vested right to that income

(which is the retained annual earnings of the trust) in the current year of assessment (because he

has a vested right to the retained annual earnings of the trust) it must be included in his income in

the current year of assessment, despite it being ‘capital’ in nature.

If the annual retained earnings do not vest in the capital beneficiaries then the provisions of

section 25B(2A) will not apply to the annual retained earnings. They will be accumulated in the

trust and will not be subject to normal tax in the Republic. Only when the trustees finally exercise

their discretion and award these accumulated annual retained earnings to a resident beneficiary

they will be deemed to be the income of this beneficiary.

No capital beneficiaries

It is possible for a trust to have no income beneficiaries and no capital beneficiaries. A trust of

this nature is sometimes referred to as a blind trust.

The provisions of section 25B(2A) will apply to a so-called blind trust.

When income is received by or accrues to the blind trust no beneficiary will be taxed on this

income because no beneficiary has a vested right to it with the result that the provisions of

section 25B(1) and (2) do not apply. And the trust will not be taxed on this income (in terms of

section 25B(1)) because it is not a resident (being an offshore trust).

When the trust’s retained income is ‘capitalised’, presumably on the first day of its following year

of assessment, because there are no capital beneficiaries at this stage, no one ‘acquires a vested

right to an amount representing capital’ which means that the provisions of section 25B(2A)

cannot apply.

It is only when a resident ‘acquires a vested right to an amount representing capital’ that the

provisions of section 25B(2A) apply. This may not occur for many years. But if, for example, say

after ten years, the trustees award the capital or a portion of the capital to a resident, then that

portion of the capital awarded which represents ‘capitalised’ retained income that has not been

subject to tax in the Republic, will be subject to the provisions of section 25B(2A), and the

resident beneficiary (of this capital) will be required to include this amount in his income.

Identity

What is not clear is whether this deemed accrual has retained its original identity.

The cases of Armstrong v CIR 1938 AD 343, 10 SATC 1 and SIR v Rosen 1971 (1) SA 173 (A), 32

SATC 249 both deal with the identity of trust income. Both are decisions of Appellate Division of

the Supreme Court and, with the exception of a qualification made in Rosen’s judgment, they

reach almost the same conclusion – this conclusion being that income that is a subject of a trust

Integritax Special Issue – March 2001 – Residence Basis of Tax page 52

retains its identity until it reaches the party in whose hands it is taxable. Both cases concerned

whether beneficiaries would qualify for the exemption from normal tax in respect of dividends

that had flowed to them through the trusts in which they were beneficiaries.

The ‘qualification’ made in the Rosen judgment was that if dividends were retained and

accumulated and then paid out subsequently, presumably in a later year of assessment, they (the

dividends) might have then lost their identity and character as dividends. If they were

subsequently paid out to the beneficiary they might possibly no longer be dividends in the

beneficiary’s hands because the conduit-pipe would had turned itself off at the relevant time.

Section 5 and many other provisions in the Act confirm that the levying of normal tax is an

annual event. Between section 5 (the levying of normal tax on an annual basis) and section 25B

(identifying in whose taxable income the annual net receipts and accruals of a trust would be

included), it seemed that the Rosen qualification could never apply. Anything retained in the trust

would as a result of these two provisions be after-tax income and would effectively become part

of the ‘capital’ of the trust.

Assume a testamentary trust’s receipts and accruals are R120 000 and its deductions and

allowances are R20 000. Further assume that no beneficiary has a vested right to the trust’s

capital or its annual receipts and accruals. Then assume that the trustees, using the discretion

given to them in terms of the will or trust deed, award and distribute R40 000 to a beneficiary out

of the trust’s R100 000 (R120 000 – R20 000) net receipts and accruals.

The provisions of section 25B result in the trust having a taxable income of R60 000 and the

beneficiary a taxable income of R40 000 arising out of the distribution made to him from the

trust. The trust will be liable for normal tax of R19 200 (R60 000 at 32%) and its after-tax income

would be R40 800 (R60 000 – R19 200). This R40 800 amount would then be added to the

‘capital’ of the trust.

If, in the next year of assessment, the trust had no receipts and accruals and no deductions and

allowances, and the trustees agreed to distribute this R40 800 ‘retained after-tax income’ to a

beneficiary, the beneficiary would receive a tax-free capital distribution from the trust.

The provisions of section 25B could not apply because they apply only to ‘any income received

by or accrued to … the trustee of a trust’. And then in terms of the definition of ‘gross income’,

receipts and accruals of a capital nature are not taxable (unless a so-called special inclusion

applies).

The above situation confirms the Rosen qualification. The identity of the receipts and accruals

that were retained and ‘capitalised’ has altered, not from one category of income to another

category of income, but instead, from income into capital. Had the R40 800 distribution been

funded by exempt dividends, the dividend exemption would be lost under the Rosen qualification,

but this would not be of concern to the beneficiary as the amount would still not be taxable

because of its capital nature (and not because it is exempt income).

Section 25B(2A) is a situation which now exists where an amount representing capital of the trust

when distributed is taxable.

It is not clear at what point in time the provisions of section 25B(2A) apply. But from the wording

of the provision it would seem that they apply in a year of assessment subsequent to ‘year one’. If

in ‘year one’ a

217. an ‘offshore’ trust, earned income,

218. no beneficiary had a vested right to this income, and

219. no South African tax was levied on this income

then the provisions of section 25B(2A) would apply, and if a resident capital beneficiary existed

who had a vested right to the retained annual earnings of the trust, then it would be on day one of

Integritax Special Issue – March 2001 – Residence Basis of Tax page 53

‘year two’ when they would apply because this would be the day on which the retained annual

earnings from ‘year one’ are ‘capitalised’ to vest in this beneficiary. But if there was no

beneficiary who had a vested right to the retained annual earnings of the trust, then the provisions

would apply only in the year of assessment when the trustees agree to distribute the now

‘capitalised’ retained annual earnings to a resident beneficiary.

It is when the resident beneficiary ‘acquires during any year of assessment any vested right to

participate in any amount representing capital’ of an offshore trust that the provisions of

section 25B(2A) apply. This would occur when the offshore trust’s retained earnings are

capitalised, which, as discussed above, probably happens on day one of ‘year two’, provided the

resident beneficiary has a vested right to the offshore trust’s capital or, if there is no capital

beneficiary, when the trustees agree to award the now ‘capitalised’ retained earnings.

And when this event occurs, then section 25B(2A) provides that this amount, being the amount by

which the resident beneficiary has benefited by, is included in the income of the beneficiary in the

year of assessment in which this benefit occurs.

But what is the identity of this amount? It is capital and it is ‘taxable’ capital. Yet could it be

argued that it still retains its identity of whatever it was before it was ‘capitalised’. This argument

would be critical in the situation where the capitalised amount was funded by exempt dividends.

The legislation gives no indication whatsoever as to the identity of this ‘capital’ amount.

It is therefore necessary to turn to case law to try to identify this amount, and when this is done, it

seems that this matter becomes a dispute between the Armstrong principle and the Rosen

qualification. The outcome of this dispute of Armstrong versus Rosen is critical to the taxpayer. If

Armstrong is followed, the capital amount (funded by exempt dividends) is exempt from taxation,

but if the Rosen qualification is followed the capital amount may be taxable – ‘may’ because this

aspect of the Rosen judgment is obiter.

ALLOWANCES AND DEDUCTIONS

Section 25B(3) provides that any deduction or allowance that may be made under the provisions

of the Act in the determination of the taxable income derived by way of any income referred to in

section 25B(1) will, to the extent to which the income is under the provisions of section 25B(1)

deemed to be income which has accrued to a beneficiary or to the trust fund, be deemed to be a

deduction or allowance that may be made in the determination of the taxable income derived by

the beneficiary or trust fund respectively. It follows that the deductions or allowances that may be

made in the determination of the taxable income derived by a beneficiary having a vested right to

income will be allowed as a deduction to the beneficiary to the extent that the income of the trust

is deemed to be his.

Discretionary trusts

Section 25(3) has been amended to the effect that its provisions will not apply to income vesting

in a beneficiary in consequence of the exercise of their discretion by the trustees of the trust.

It is not clear whether the beneficiary’s disallowed deductions or allowances will be available to

the trust.

It is understood that it will be the practice of the Commissioner to allow the trust to deduct the

amount that would have been deductible by the beneficiary had this prohibition not existed.

((2001) 15 Tax Planning 4)

INCOME

What is not clear in section 25B (1), (2) and (3), is what meaning to give to the word ‘income’ as

used in the provision. Similar provisions to section 25B are section 7 and the ‘old’ section 25.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 54

And in these provisions ‘income’ does not mean ‘gross income less exempt income’, but it means

‘net profits’. Support for this submission comes from the judgment in CIR v Simpson 1949 (4) SA

678 (A), 16 SATC 268. But this principle cannot apply to section 25B because this provision deals

separately with ‘receipts and accrual’ and ‘expenditure and allowances’. It is therefore submitted

that ‘income’ as used in section 25B (1), (2) and (3) must mean ‘an amount’, and not ‘gross

income less exempt income’.

LIMITATION OF ALLOWANCES AND DEDUCTIONS

Section 23B(4) provides that the deductions and allowances which are deemed to be deductions

and allowances of the beneficiary in terms of section 25B(3), be limited to the income of the

beneficiary derived from the trust during the year of assessment.

TRANSFER OF NON-DEDUCTIBLE ALLOWANCES AND DEDUCTIONS

Where the aggregate of the deductions and allowances exceeds the income of the beneficiary,

section 25B(5)(a) provides that the excess may be set off against the taxable income of the trust

during the relevant year of assessment, provided that the excess does not exceed the taxable

income of the trust, as calculated before allowing the above-mentioned set-off.

Section 25B(5)(b) provides that if the trust is not subject to tax in the Republic, any ‘excess’

deductions and allowances of a beneficiary having a vested right to the income of the trust may

not be set off against the income of the trust, but must instead be carried forward to the next year

of assessment. This excess will be deemed to be a deduction or allowance available to the

beneficiary in the next year of assessment.

CARRY FORWARD OF NON-DEDUCTIBLE ALLOWANCES AND DEDUCTIONS

Section 25B(6) specifies that where the aggregate of the deductions and allowances contemplated

in section 25B(4) exceeds both the income contemplated in section 25B(4) of the beneficiary and

the taxable income of the trust contemplated in section 25B(5), this excess may be set off against

the income of the beneficiary which is derived from the trust in the immediately succeeding year

of assessment. The effect of the application of the provisions of section 25B(6) is that the excess

carried forward may then be allowed as a deduction as envisaged in section 25B(3), (4) and (5)

during the succeeding year.

EXAMPLES OF SECTION 25B(4), (5) AND (6)

These provisions are illustrated in the following two examples.

Example 1

A trust’s receipts and accruals comprise rentals of R100 and interest of R50. Its deductions and

allowances amount to R125, of which R120 relates to its rentals and R5 to its interest. A

beneficiary has a vested right to the rentals. Nobody has a vested right to the interest.

Solution

Beneficiary

Gross income (rentals)-in terms of section 25B(1) 100

Allowances and deductions-in terms of section 25B(3)-but limited in terms of section 25(4) 100

Taxable income –

Allowances and deductions-total in terms of section 25B(3) 120

Deductions allowed (see above) 100

Carried forward to the trust (see below)-in terms of section 25B(5) 20

Integritax Special Issue – March 2001 – Residence Basis of Tax page 55

Trust

Gross income (interest) 50

Allowance and deductions

– actual (in terms of Practice Note 31) 5

– deemed in terms of section 25B(5)–see above 20 25

Taxable income 25

Example 2

A trusts receipts and accruals comprise rentals of R100 and interest of R50. Its deductions and

allowances amount to R165, of which R160 relates to its rentals and R5 to its interest. A

beneficiary has a vested right to the rentals. Nobody has a vested right to the interest.

Solution

Beneficiary – Year 1

Gross income (rentals) – in terms of section 25B(1) 100

Allowances and deductions in terms of section 25B(3) but limited in terms of section 25B(4) 100

Taxable income –

Allowances and deductions-total 160

Deductions allowed (see above) 100

Carried forward to the trust (see below) in terms of section 25B(5) 60

Trust

Gross income (interest) 50

Allowance and deductions

– actual (in terms of Practice Note 31) 5

– deemed in terms of section 25B(5)-see above but limited in terms of the proviso

to section 25B(5)

45

50

Taxable income –

Beneficiary – Year 2

Deemed expenditure in terms of section 25B(6) 15

DISQUALIFIED ALLOWANCES AND DEDUCTIONS

As detailed above section 25B(4), (5) and (6), limit the amount of deductions and permit the

‘transfer’ of a beneficiary’s disallowed deductions to the trust to the extent of its qualifying

income.

A new section 25B(7) provides that the provisions of section 25B(4), (5) and (6), will not apply to

income deemed to accrue to a beneficiary under section 25B(1), being income to which a

beneficiary has a vested right, if the beneficiary will not be subject to tax on it in the Republic.

The effect of section 25B(7) is not at all clear.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 56

220. First, if the provisions of section 25B(4) do not apply, this means that the beneficiary will

not have any limit placed on the amount of the deductions and allowances he is entitled to

claim

221. Secondly, if the provisions of section 25B(5) do not apply, no transfer of deductions and

allowances from a beneficiary to the trust will be permitted.

222. Thirdly, if the provisions of section 25B(6) do not apply, the transfer of the deductions

and allowances from the trust to the beneficiary for possible deduction in the next year of

assessment will not be allowed.

But if the income of the beneficiary is not to be taxed in the Republic on the income that vests in

him from the trust, for example, because it is ‘exempt income’, then the provisions of

section 23(f) will apply, and no deduction or allowance will be granted to the beneficiary. The

consolidated effect of section 25B(4) and (7) and section 23(f) would seem to be that the

beneficiary will not be entitled to any deduction or allowance.

And then the effect of section 25B(7) on section 25B(5) and (6) is that

223. the trust will not be able to deduct the deductions and allowances that the beneficiary has

been prohibited from deducting, and

224. the carrying forward to the following year of assessment of the deductions and

allowances that have not yet been deducted will not be permitted.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 57

CONTROLLED FOREIGN ENTITIES

INTRODUCTION

Section 9D provides certain anti-avoidance measures in relation to the income of a ‘controlled

foreign entity’ (CFE).

SECTION 9D

To give effect to the taxation of the resident ‘owners’ of a CFE, section 9D was enacted. It splits

into the following provisions.

225. Section 9D(1) is the definition provision containing definitions of a ‘business

establishment’, a ‘controlled foreign entity’ terms, a ‘designated country’ a ‘foreign entity’

and ‘participation rights’.

226. Section 9D(2) deems a portion of a CFE’s net income to be included in the income of a

resident.

227. Section 9D(2A) gives the basis that the ‘net income’ of a CFE is determined.

228. Section 9D(3) has been repealed.

229. Section 9D(4) has been repealed.

230. Section 9D(4A) has been repealed.

231. Section 9D(5) has been repealed.

232. Section 9D(6) provides the method used to convert foreign income into the currency of

the Republic.

233. Section 9D(7) has been repealed.

234. Section 9D(8) has been repealed.

235. Section 9D(9) provides for five situations when the net income of a CFE will not be

deemed to be the resident’s income.

236. Section 9D(10) allows the Minister of Finance, subject to certain conditions, to treat more

than one foreign country as a single country.

237. Section 9D(11) provides for some exemptions to be withdrawn if a resident fails to

comply with certain reporting requirements.

DEFINITIONS

Five terms are defined in section 9D(1).

Business establishment

A ‘business establishment’ in relation to a CFE is defined as follows:

‘a place of business with–

(a) an office, shop, factory, warehouse, farm or other structure which is

used or will continue to be used by the controlled foreign entity for a

period of not less than one year;

(b) a mine, oil, or gas well, a quarry or any other place of extraction of

natural resources; or

(c) a site for the construction or installation of buildings, bridges, roads,

pipelines, heavy machinery or other projects of comparable

magnitude which lasts for a period of not less than six months,

whereby the business of such entity is carried on, and where–

Integritax Special Issue – March 2001 – Residence Basis of Tax page 58

(i) such place of business is suitably equipped with on-site operational

management, employees, equipment and other facilities for the

purposes of conducting the primary operations of such business;

and

(ii) such place of business is utilised outside the Republic for a bona fide

business purpose (other than the avoidance, postponement or

reduction of any liability for payment of any tax, duty or levy

imposed by this Act or by any other law administered by the

Commissioner)’.

Controlled foreign entity

A ‘controlled foreign entity’ is defined as any ‘foreign entity’ in which ‘residents’ of the

Republic, whether individually or jointly or whether directly or indirectly hold more than 50% of

the ‘participation rights’ or are entitled to exercise more than 50% of the votes or control of the

entity.

Designated Country

A designated country is defined as a designated country as defined in section 9E.

Foreign entity

A ‘foreign entity’ is a person, other than a natural person or a trust, that is not a resident, or is a

resident but as the result of the application of the provisions of a double taxation agreement

entered into by the Republic is treated as not being a resident. It excludes a trust from being a

foreign entity, and, therefore, a CFE.

Participation rights

The term ‘participation rights’ means the right to directly or indirectly participate in the capital or

profits of, or dividends declared by, or any other distribution or allocation made by the entity.

ANTI-AVOIDANCE MEASURES

The provisions of section 9D are in the nature of anti-avoidance measures to prevent a situation

whereby a ‘resident’ invests capital offshore not in his (the resident’s) own name, but through an

offshore entity whereby taxable income is re-characterised and converted into exempt income

which is not taxable. Section 9D contains various anti-avoidance measures to combat this

possible tax avoidance scheme.

PROPORTIONAL AMOUNT

Section 9D(2) provides that there shall be included in the income of any ‘resident’ in relation to a

‘controlled foreign entity’ a proportional amount of the income received by or accrued to this

‘foreign entity’, which is attributable to his ‘participation rights’ in this ‘foreign entity’.

With the introduction of the world-wide basis of taxation of all income, the provisions of

section 9D(2) now apply to all income.

Included in the income of a resident is the proportional amount of the income received by or

accrued to the entity which bears to the ‘net income’ received by or accrued to the entity the same

ratio as the percentage of the participation rights of the resident in relation to the entity.

Net income

He must include in his income for his year of assessment his proportional amount of the ‘net

income’ of the entity for the foreign tax year of the entity ending during his year of assessment.

The term ‘net income’ is defined in section 9D(2A) as an amount equal to the taxable income of

the entity determined in accordance with the Act as if it were a resident. The provisions of the

South African Income Tax Act must therefore be applied to calculate its taxable income subject to

Integritax Special Issue – March 2001 – Residence Basis of Tax page 59

the following two qualifications.

238. First its deductions and allowances are limited to its income. The amount by which the

deductions and allowances exceed its income is carried forward to the immediately succeeding

year of assessment and is deemed to be a balance of assessed loss that may be set off against

the income of the entity in its next year of assessment.

239. Secondly, no deduction will be allowed for any interest, royalties or rental paid by the

entity to any other CFE in relation to the resident concerned as contemplated in

section 9D(9)(fA). Section 9D(9)(fA), provides that the provisions of section 9D do not apply

in relation to the proportional amount of an amount equal to the net income of a CFE that is

attributable to any resident, to the extent that it relates to any interest, royalties or rental that is

paid to the entity by any other CFE in relation to the resident. Between these two provisions the

deduction of interest, royalties and rentals paid between entities that are both CFEs in relation

to the same resident is prohibited.

Exclusion

The provisions of section 9D(2) do not apply when the resident (together with his connected

persons in aggregate) at all times during the foreign tax year holds less than 10% of the

participation rights and is entitled to exercise less than 10% of the voting rights in the CFE. This

means that residents holding less than 10% of the participation or voting rights in a CFE will not

be required to include any amount of its income in their income.

Example

A company incorporated in South Africa conducts business activities through branches in

Botswana and Mauritius. It also operates through a wholly-owned subsidiary in Brazil (which

is therefore a CFE as defined).

During its 2002 year of assessment none of the exemptions contained in sections 9D and 9F

apply to the profits generated by the branches or subsidiary. The activities for its year resulted

in the following taxable incomes or losses calculated by the provisions of the South Africa

Income Tax Act after conversion into rands:

South African company

240. South Africa activities – a taxable income of R5 000 000.

241. Botswana activities – a loss of R3 000 000.

242. Mauritius activities – a taxable income of R1 000 000.

Brazilian company (the CFE)

243. Brazilian activities – a loss of R2 000 000.

The South African company will be taxed on a taxable income of R5 000 000. The foreignsourced

income from its branches resulted in an assessed loss of R2 000 000 (R3 000 000 loss

from Botswana less R1 000 000 taxable income from Mauritius) which will be carried forward

to its 2003 year of assessment to be set off against foreign-sourced income. The provisions of

section 9D apply to the Brazilian company. But as the allowance and deductions of a CFE

cannot exceed its income, the deemed inclusion in the South African company’s taxable

income from its CFE is ‘nil’.

The loss of the Brazilian subsidiary (which is a CFE as defined) will be carried forward to be set

off against its own income during its following year of assessment.

EXCHANGE RATE

Section 9D(6) provides that the amount to be included in the income of a resident must be

converted to the currency of the Republic. The conversion must occur on the last day of the

Integritax Special Issue – March 2001 – Residence Basis of Tax page 60

foreign tax year of the CFE. The rate to be used is the ruling exchange rate on the relevant date. It

may, however, be any other exchange rate or rates approved by the Commissioner, determined

with reference to the ruling exchange rate or rates during the year.

EXEMPTIONS

Designated countries

Section 9D(9)(a) effectively makes section 9D inapplicable to receipts and accruals of a CFE that

is a company when they have been or will be subject to tax on income in a designated country at a

statutory rate of at least 27%. The legislation refers to a ‘statutory’ rate because an effective tax

rate takes into account special losses and deductions or incentives available in the calculation of

the actual tax liability of a company. The rate must be payable without any right of recovery after

taking into account the application of any double taxation agreement. If the designated country

imposes tax on a company at a progressive scale of statutory rates, the statutory rate is deemed to

be the highest rate on the scale.

Business establishment

Section 9D(9)(b) makes section 9D inapplicable to the net income of a CFE that is a company

which is attributable to a ‘business establishment’ of the CFE in a country other than the Republic

(see above – the definition of a ‘business establishment’).

But not all the receipts and accruals of a ‘business establishment’ are exempt from the provisions

of section 9D. Certain of its receipts and accruals are considered by the legislature not to be

‘genuine’ transactions (generally referred to a ‘diversionary transactions’). These so called

diversionary transactions of a CFE are therefore subject to the provisions of section 9D

First, the receipts and accruals of a ‘business establishment’ which are subject to the provisions of

section 9D are those derived from transactions with a connected person in relation to the CFE who

is a resident relating to the supply of goods or services by or to the CFE, unless the consideration

in respect of the transactions reflects an arm’s length price that is consistent with the provisions of

section 31 (section 9D(9)(b)(i)).

Secondly, the receipts and accruals derived from a sale of goods by the CFE to a connected person

in relation to the CFE who is a resident, are also subject to the provisions of section 9D, unless,

244. the CFE purchased the goods within the country of residence of the CFE from a person

who is not a connected person in relation to the CFE;

245. the creation, extraction, production, assembly, repair or improvement of goods

undertaken by the CFE amount to more than minor assembly or adjustment, packaging,

repackaging and labelling; or

246. the CFE sells a significant quantity of goods of the same or a similar nature to persons

who are not connected persons in relation to the CFE, at comparable prices (after accounting

for the level of the market, volume discounts and costs of delivery).

Thirdly, the receipts and accruals derived from a sale of goods by the CFE to a person, other than a

connected person in relation to the CFE who is a resident, where the CFE initially purchased the

goods or any tangible intermediary inputs of the goods from one or more connected persons in

relation to the CFE who are residents, are also subject to the provisions of section 9D, unless,

247. the goods or tangible intermediary inputs purchased from connected persons in relation to

the CFE who are residents amount to an insignificant portion of the total tangible intermediary

inputs of the goods;

248. the creation, extraction, production, assembly, repair or improvement of goods

undertaken by the CFE amount to more than minor assembly or adjustment, packaging,

repackaging and labelling; or

Integritax Special Issue – March 2001 – Residence Basis of Tax page 61

249. the products are sold by the CFE to persons who are not connected persons in relation to

the CFE for delivery within the country of residence of the CFE.

Fourthly, the receipts and accruals derived from any service performed by the CFE to a connected

person in relation to the CFE who is a resident, are also subject to the provisions of section 9D,

unless

250. the service is performed outside the Republic, and

251. the service relates directly to the creation, extraction, production, assembly, repair or

improvement of goods used within one or more countries outside the Republic; or

252. the services relate directly to the sale or marketing of goods of a connected person in

relation to the CFE who is a resident and the goods are sold to persons who are not connected

persons in relation to the CFE for delivery within the country of residence of the CFE.

As far as the second, third and fourth situations as set out above in terms of which the receipt and

accruals of a ‘business establishment’ may be subject to the provisions of section 9D are

concerned, the Minister of Finance may make the following determinations.

253. He may by notice in the Gazette determine that one or more foreign countries be treated

as one if the foreign countries comprise a single economic market and this treatment will not

lead to an unacceptable erosion of the tax base.

254. He may also, in consultation with the Commissioner, grant exemption to any person from

the application of the above provisions (the second, third and fourth situations) to the extent

that its application will unreasonably prejudice national economic policies or South African

international trade and the exemption will not lead to an unacceptable erosion of the tax base.

Fifthly (and finally), receipts and accruals in the form of dividends, interest, royalties, rental,

annuities, insurance premiums or income of a similar nature (passive income) of a ‘business

establishment’ will be subject to the provisions of section 9D unless

255. they do not in total exceed 5% of the total receipts and accruals of the CFE, or

256. the principle trading activities of the CFE are any banking or financial services, insurance

or rental business.

But the ‘passive’ receipts and accruals of a CFE which conducts banking or financial services, and

any insurance or rental business in a ‘business establishment’ will be subject to the provisions of

section 9D if these receipts and accruals are from any

257. connected person in relation to the CFE who is a resident; or

258. resident, to the extent that these receipts and accruals are produced as part of a scheme for

the purpose of avoiding liability for any tax, duty or levy imposed in terms of the Act or any

other law administered by the Commissioner.

This ‘business establishment’ exemption will not apply to a resident who fails to comply with the

reporting requirements as set out in section 72A (see below).

South African taxable income

Section 9D(9)(e) exempts from the application of section 9D the net income of a CFE to the extent

that it is included in its taxable income. This means that if the income of a CFE has already been

included in the taxable income of a CFE under the Act it will not be attributed to the resident

holding participation rights in the CFE. An example of this would be rentals earned by a CFE from

a rent-producing property situated in the Republic.

Foreign dividends

Section 9D(9)(f) exempts from the application of section 9D the proportional amount of an

amount equal to the net income attributable to a resident, to the extent that it relates to a foreign

Integritax Special Issue – March 2001 – Residence Basis of Tax page 62

dividend contemplated in section 9E declared to a CFE that is a company by any other company

that is a CFE in relation to the resident. This means that a resident holding participation rights in a

CFE that derives a foreign dividend from another CFE in relation to that resident will not be taxed

on his proportional amount of that foreign dividend. But it must be stressed that this exemption

will not apply to a resident who fails to comply with the ‘reporting requirements as set out in

section 72A (see below).

Interest, royalties and rentals

Section 9D(fA) exempts from the application of section 9D the proportional amount of an amount

equal to the net income attributable to a resident, to the extent it relates to any interest, royalties

or rentals paid by a CFE to another CFE in relation to the resident. This means that a resident

holding participatory rights in a CFE that derives any interest, royalties or rentals from another

CFE in relation to that resident will not be taxed on his proportional amount of the interest,

royalties or rentals. But it must be stressed that this exemption will not apply to a resident who

fails to comply with the ‘reporting’ requirements as set out in section 72A (see below).

REPORTING REQUIREMENTS

Section 9D(11) makes certain exemption from section 9D not available if the provisions of

section 72A are not complied with. And then section 72A contains most demanding disclosure

requirements. It applies to every resident who during a year of assessment

259. directly or indirectly holds not less than 10% of the participation or voting rights or

control in a CFE; and

260. together with his connected persons in aggregate holds more than 50% of the total

participation or voting rights or control in the CFE.

Section 72A(1) provides that this resident is then required to submit a return to the Commissioner

reflecting certain information about the CFE. The Commissioner will prescribe the form of the

return and the time period for its submission. This requirement does not apply to a resident whose

connected person is also a resident and who holds a greater percentage of the participation rights

in the CFE than he does. In other words, it is the resident who holds the greatest participation

rights in a CFE who is, in the first instance, required to report the relevant information to the

Commissioner.

The return for a particular CFE must provide the information as detailed below. The information

must be provided to both the Commissioner and to other residents who hold directly or indirectly

not less than 10% of the participation or voting rights of the CFE.

261. The name, address and country of residence of the CFE (section 72A(2)(a)).

262. A description of the various classes of the participation rights in the CFE

(section 72A(2)(b)).

263. The percentage and class of participation rights held by any other resident who is a

connected person of the first resident and directly or indirectly holds not less than 10% of the

participation or voting rights in the CFE (section 72A(2)(d)).

264. A description of any amount of tax proved to be payable by the CFE to the government of

any other country on income included in the resident’s income in terms of section 9D.

Particulars of the country in which the tax was payable and the underlying profits to which the

foreign tax relates must also be provided (section 72A(2)(f)).

On receipt of this information, the other resident, must, in turn, submit it to the Commissioner in

the form and manner as the Commissioner may prescribe.

The resident must also supply the Commissioner (but not the ‘other’ person) with the following

information:

Integritax Special Issue – March 2001 – Residence Basis of Tax page 63

265. The percentage and class of participation rights held by him (the resident), whether

directly, indirectly or together with his connected persons (section 72A(2)(c)).

266. A description of the receipts and accruals of the CFE that are either included in his (the

resident’s) income in terms of section 9D or are not included in his income because they are

exempt in terms of section 9D(9) (section 72A(2)(e)).

In addition, in terms of section 72A(3)(b) the resident must have available for submission to the

Commissioner if so requested an income statement and balance sheet of the CFE prepared in

accordance with the laws of the country in which the CFE is a resident or in accordance with

internationally accepted accounting practice.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 64

Textual and Consequential Amendments

INTRODUCTION

The creation of a definition of a ‘resident’, the scrapping of the definitions of a ‘domestic

company’, an ‘external company’ and a ‘South African company’, the replacement of references

to persons ‘ordinarily resident’ in or outside the Republic with references to persons who are or

are not ‘residents’ and the elimination of references to companies managed and controlled outside

the Republic have resulted in textual changes being made to a number of provisions in the

legislation. Set out below is a summary of these ‘textual’ or ‘consequential’ changes.

GROSS INCOME

Know-how

Paragraph (gA) of the definition of ‘gross income’ includes in gross income any amount received

or accrued from another person as consideration for the imparting of ‘specified’ knowledge or

information for use in the Republic, or for the rendering of any assistance in the use of that

knowledge or information. The term ‘for use in the Republic’ has been deleted. The provision is

now applicable to a resident no matter where the knowledge or information is to be used. An

amount received by a non resident for use of information will not be from a Republic source (true

or deemed) with the result that the provisions of paragraph (gA) cannot apply to a non resident.

Foreign dividends

Paragraph (k) of the definition of ‘gross income’ included in gross income any amount received

or accrued by way of any foreign dividend received by or accrued to any person who is a resident

as defined in section 9E. With the introduction of the definition of a ‘resident’ in section 1 and the

deletion of the definition of a ‘resident’ in section 9E, the term ‘a resident as defined in

section 9E’ has been deleted.

Deferred recoupment

Section 8(4)(b) provides a deferred recoupment concession in respect of certain allowances for

ships. Its reference to section 9(1)(c) has been replaced by a reference to a ‘resident who carries

on any business as owner or charterer of any ship’.

Deemed source

The references in section 9(1A) to section 9(1)(d)bis and (f), all of which have been repealed,

have been deleted.

EXEMPTIONS

The following exemptions have all been amended by textual changes.

267. Section 10(1)(cA) – certain bodies conducting research, providing certain commodities,

amenities or services to the state or the general public or carrying on activities designed to

promote commerce, industry or agriculture.

268. Section 10(1)(cG) – owners or charterers of ships or aircraft.

269. Section 10(1)(h) – interest from Government or semi-governmental bodies.

270. Section 10(1)(hA) – interest accruing to non residents.

271. Section 10(1)(k)(i)(aa) – dividends distributed to property unit trusts.

272. Section 10(1)(k)(i)(dd) – taxable foreign dividends.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 65

ALLOWANCES AND DEDUCTIONS

General deduction formula

Section 11(a) provided a deduction for expenditure and losses actually incurred ‘in the Republic’

in the production of the income, provided they are not of a capital nature. The requirement that

the expenditure and losses be incurred ‘in the Republic’ has been deleted.

Section 11(b) provided a deduction for expenditure and losses actually incurred ‘outside the

Republic’ in the production of the income, provided they are not of a capital nature. This

provision has been deleted.

Patents and similar assets

Section 11(gA)(ii) allows a deduction for expenditure incurred by a taxpayer in obtaining or

registering a patent or similar assets. This provision has been amended to refer to registration

under similar laws of any other country in addition to under the appropriate Republic Acts.

Know-how

Section 11(gA)(cc) provides an allowance in respect of intellectual property or knowledge

acquired before 1 July 1993. Added to its reference to a person who is a ‘resident’ of a

neighbouring country is a reference to a person who is ‘ordinarily resident’ in a neighbouring

country. Its reference to a ‘domestic company or a company incorporated, managed or controlled’

has been replaced by a reference to ‘a company that is incorporated or has its place of effective

management’.

Section 11(gA)(dd) limits the amount on which the allowance may be claimed when it is acquired

from a connected person of the taxpayer if that person is a ‘resident of the Republic or a

neighbouring country’ and in the situation of a company, ‘a domestic company or a company

incorporated, managed or controlled in a neighbouring country’. The reference to a ‘resident of

the Republic or of a neighbouring country’ has been replaced by a reference to a person who is ‘a

resident of the Republic or who is ordinarily resident in a neighbouring country’. And the term ‘a

company, is incorporated or has its place of effective management in a neighbouring company’

has replaced the term ‘a domestic company or a company incorporated, managed or controlled in

a neighbouring country’.

Section 11(gB) allows a deduction for expenditure incurred by a taxpayer in obtaining the

extension of the term of a patent or a similar asset under its appropriate Act . This provision has

been amended to refer to ‘similar laws of any other country’ in addition to the appropriate

Republic legislation.

Aircraft

Section 14bis provides an allowance for certain ‘qualifying’ aircraft. References in section 14bis

to section 9(1)(c), which has been repealed, have been replaced with either the word ‘resident’ or

with the term ‘a resident who carries on any business as owner or charterer of any aircraft’.

Medical expenses

Section 18(1)(a) provides the deduction for contributions to any medical scheme registered under

the provisions of the Medical Schemes Act 131 of 1998. Its provisions have been amended to

allow the deduction also for contributions to ‘any fund which is registered under a similar

provision contained in the laws of any other country where the medical scheme is registered’.

FOREIGN EXCHANGE

For the provisions of section 24I(2)(a) to apply to a person, he must be carrying on a trade ‘within

the Republic’. The term ‘in the Republic’ has been repealed which means that its provisions now

cater for the determination of the taxable income of any person derived from carrying on a trade,

no matter where that trade is carried on.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 66

The definition of a ‘foreign currency’ in section 24I(1) has been expanded to include a trade

carried on within the Republic and one carried on in a country outside the Republic.

References to the term ‘within the Republic’ have also been removed from section 24I(2)(b) and

(4)(a).

273. In relation to a trade carried on by a person within the Republic a ‘foreign currency’ is

any currency that is not legal tender in the Republic, and

274. in relation to a trade carried on by a person in a country outside the Republic a ‘foreign

currency’ is any currency that is not legal tender in that other country.

TRANSFERS OF FOREIGN BUSINESS UNDERTAKINGS

Section 28bis(1)(a) and (b) has been amended to replace references to companies ‘incorporated,

managed and controlled in the Republic’ and ‘outside the Republic’ with references to companies

that are residents or are not residents respectively.

TRANSFER PRICING

The definition of an ‘international agreement’ in section 31(1) referred in three sub-paragraphs to

a natural person ordinarily resident in the Republic or a person other than a natural person

managed or controlled in the Republic. In all three sub-paragraphs this term has been replaced by

a reference to ‘a resident’. Three references in this definition to a natural person ordinarily

resident outside the Republic or a person other than a natural person managed or controlled

outside the Republic have all been replaced by a reference to a person who ‘is not a resident’.

The definition of an ‘international agreement’ has been extended by the addition of a new

paragraph, namely, paragraph (d), which refers to an agreement between two residents if either of

them is as a result of the provisions of a double taxation agreement entered into by the Republic

not subject to tax in the Republic.

The definition of an ‘international agreement’ also referred to a permanent establishment ‘as

contemplated in section 9C(1)’. The term ‘as contemplated in section 9C(1), has been deleted.

The definition of a ‘permanent establishment’ which used to be in section 9C(1) is now in

section 31(1).

In section 31(3) the term ‘a natural person ordinarily resident in the Republic or a person other

than a natural person managed or controlled in the Republic’ has been replaced by a reference to

‘a resident’. And the term ‘a natural person ordinarily resident outside the Republic or a person

other than a natural person managed or controlled outside the Republic’ has been replaced by a

reference to ‘a person who is not a resident’.

SHIPS AND AIRCRAFT

Section 33 deals with foreign owners or charterers of ships or aircraft. In section 33(1) the term

‘not being a person ordinarily resident in the Republic or a domestic company’ has been replaced

by the term ‘other than a resident’.

DONATIONS TAX

Section 54 levied donations tax on donations made by a donor ‘who, in the case of a person other

than a company, is ordinarily resident in the Republic, or, in the case of a company, is a domestic

company’. This provision has been amended by replacing this term with the word ‘resident’.

Section 56(1)(g)(i) exempted property disposed of under a donation from donations tax if the

property consisted of a right in property situated outside the Republic and was acquired by the

donor before the donor, being a person other than a company, became ordinarily resident in the

Republic for the first time or, if a company, became a domestic company for the first time. This

exemption has been amended to apply when the property was acquired by a donor before the

donor became a ‘resident of the Republic’ for the first time.

Integritax Special Issue – March 2001 – Residence Basis of Tax page 67

TAX AVOIDANCE

In section 103(3) the term ‘person (other than a company) who is ordinarily resident or carrying

on business in the Republic’ has been replaced by the word ‘resident’. The term ‘registered or

incorporated in the Republic’ has been replaced by the term ‘which is a resident’. And the term

‘(other than a company) not, ordinarily resident or carrying on business in the Republic or to any

company registered outside the Republic’, has been replaced by the term ‘who is not a resident’.

PROVISIONAL TAX

Directors

Paragraph (b) of the definition of ‘provisional taxpayer’ include as a provisional taxpayer, a

director of a private company who is ordinarily resident in the Republic or if the company is

managed and controlled or has its registered office in the Republic. This paragraph has been

amended to make a director of a private company a provisional taxpayer if he or the company is a

‘resident’.

Members

Paragraph (bA) of the definition of ‘provisional taxpayer’ included as a provisional taxpayer, a

member of a close corporation if he is ordinarily resident in the Republic. This paragraph has

been amended by replacing the term ‘ordinarily resident in the Republic’ with the term a

‘resident’.

EMPLOYEES’ TAX

Representative employer

The definition of a ‘representative employer’ has been amended to the effect that a representative

employer must be a resident.

Deduction of PAYE

In terms of paragraph 2(1) employers who are liable to pay remuneration must deduct PAYE. This

paragraph has been amended to apply only to

 an employer who is a resident, or

 a representative employer in the situation of an employer who is not a resident.

LOAN LEVY

In terms of paragraph 2(3) of the Fifth Schedule a person other than a company who is not

ordinarily resident and is not carrying on business in the Republic and a company that is not a

South African company and is not carrying on business in the Republic is exempt from the loan

levy. This provision has been amended to make the exemption available to a person who is not a

‘resident’ and is not carrying on business in the Republic.

FRINGE BENEFITS

The definition of the ‘official rate of interest’ in the Seventh Schedule has been extended to

include ‘foreign’ loans. For ‘local’ loans it is the rate of interest fixed by the Minister from time

to time by notice in the Gazette. For ‘foreign’ loans it is ‘a market related rate of interest’.

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